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-Skilled labour is hard to recruit
-The workers concerned were transferred to the contract from production department and at a recent meeting, the production manager claimed that if the men were returned to him they could generate sales of $150,000 in the next yearThe prime cost of these sales would $100,000 including $40,000 for the labour cost itself
The overhead absorbed into this production would amount to $20,000
Sir, I don’t have problem to calculate the relevant costing which is $90,000. The only problem I have is why we deduct it instead of adding it?
You have not said what it is being deducted from, and so without seeing the whole question I cannot really answer you.
A research contract, which to date has cost the company $150,000, is under review.
If the contract is allowed to proceed:
it will be completed in approximately one year
the results would then be sold to a government agency for $300,000.
Shown below are the additional expenses which the managing director estimates will be necessary to complete the work.Materials
This material for the contract has just been purchased at a cost of $60,000.
It is toxic; if not used in this contract it must be disposed of at a cost of $5,000.
LabourSkilled labour is hard to recruit.
The workers concerned were transferred to the contract from a production department, and at a recent meeting, the production manager claimed that if the men were returned to him they could generate sales of $150,000 in the next year.
The prime cost of these sales would be $100,000, including $40,000 for the labour cost itself.
The overhead absorbed into this production would amount to $20,000.
Research staffIt has been decided that when work on this contract ceases, the research department will be closed.
Research wages for the year are $60,000, and redundancy and severance pay has been estimated at $15,000 now, or $35,000 in one year’s time.
EquipmentThe contract utilises a special microscope which cost $18,000 three years ago.
It has a residual value of $3,000 in another two years, and a current disposal value of $8,000.
If used in the contract it is estimated that the disposal value in a year’s time will be $6,000.
Share of general building servicesThe contract is charged with $35,000 pa to cover general building expenses.
Immediately after the contract is discontinued, the space occupied could be sub-let for an annual rental of $7,000.
Required:Advise the managing director as to whether the contract should beallowed to proceed, explaining the reasons for the treatment of eachitem.
(Note: Ignore the time value of money.)
My question is about the skilled labour which is $90,000. According to the answer we have to deduct it.
It is because taking the skilled labour for the contract is an opportunity cost of doing the contract – it is losing contribution that otherwise would be earned.
Have you watched my free lectures on relevant costing?
Yes, I did watch your lecture and I understand that this is an opportunity cost. I calculated it correctly.
However, when I look at the answer given.
(1)Costs to date of $150,000 sunk-Ignore
(2)Materials $5,000
(3)Labour cost ($90,000)
(4)Research staff costs ($60,000)
Wages for the year ($20,000)
(5)equipment ($8,000)
Deprival value if used in the project $6,000
(6)general building services ($7,000)
-Total relevant cash flow associated with the contract ($174,000)
-Sales Value of contract $300,000
-Increased contribution from contract $126,000I know how to calculate the opportunity cost for the labour which is $90,000.my problem is when we calculate the total relevant cash flow associated with the contract above, I don’t understand why we deduct the $90,000 for the labour cost? Is it because we saved money?
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