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A company is planning to bid for a one-month contract. It has sufficient spare labour and machine capacity to carry out the contract without affecting other activities. Costs associated with the contract would be as follows:
Direct materials
12,440
Direct labour
18,300
Variable overheads
6,020
Depreciation
2,000
In addition, it is estimated that a supervisor will need to spend 50% of their time on that contract. The supervisor is paid $3,500 a month.
What is the relevant cost of the contract?
??$18,460
??$12,440
??$20,210
$14,190I have understand everything
but have a doubt on supervisory cost, like they spend 50% of their time on the contract means they need to be paid half of $3500
so $1750 supervisory cost in relevant yeahYes it clearly states that by “ In addition, it is estimated that a supervisor will need to spend 50% of their time on that contract. The supervisor is paid $3,500 a month. “
Supervisor’s cost 50% of 3,500 is 1,750
QUESTION:
I came across this past exam-style question:
Cleverclogs is short of labour for a new one-off project needing 600 hours of labour and has choices as to where to source this. They could hire new people temporarily from an agency at a cost of $9 per hour. Alternatively, they could recruit new temporary staff at a fixed cost of advertising of $1,200 but then only pay $6 per hour for the time. They could also redirect some staff from existing work who are currently paid $7 per hour and who make sandals that generate a contribution of $3 per hour after all variable costs. Sandals are a good selling product and Cleverclogs will lose the production and the related sales whilst staff is working on the new one-off project. What is the relevant cash flow?
The textbook gives the correct answer as $4,800, which is the least costly option (hiring new people via recruitment: $1,200 + 600×$6). That makes sense.
However, my query is about the treatment of existing labour:
The internal redirection method is calculated as:
600 × ($7 + $3) = $6,000I don’t fully agree with this method.
The labour is already employed and being paid $7/hour. This cost will continue whether they work on sandals or on the new project. So, the $7/hr is not an incremental cost. Therefore, the only relevant cost here should be the lost contribution of $3/hour, giving:
600 × $3 = $1,800I found a previous reply by a tutor to a similar student query, which said:
> “If labour is being diverted, then the relevant cost is always the lost contribution plus the labour cost. The labour is still going to be paid, and therefore what is lost is the sales revenue less the other variable costs, which is the same as the contribution plus the labour cost.”
This is where I need clarification.
We are not disputing the $4,800 answer. Our doubt is in why the $7/hr wage is treated as relevant when the labour is already being paid — it seems to us that the only opportunity cost is the forgone contribution. Can you kindly explain when we should or shouldn’t include such fixed labour cost in relevant costing?
Thank you!
Labour is already employed and being paid, the key consideration is whether the cost is incremental or not.
So the existing labour cost of $7 per hour is indeed a sunk cost, as it will be incurred regardless of whether the labour is redirected to the new project or continues with the current work.
However, when labour is diverted to a new project, the relevant cost includes both the lost contribution from the existing work and the labour cost, because the labour is still being paid.
600 hours × (7+3) = $6,000.The relevant cost is thus the sum of the lost contribution and the labour cost, as both contribute to the financial implications of the decision.
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