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Hello,
A mining operation uses skilled labour costing $4/hr, which generates a contribution, after deducting these labour costs, of $3/hr.
A new project is now being considered which requires 5,000 hours of skilled labour. There is a shortage of the required labour. Any labour used on the new project must be transferred from normal working. What is the relevant cost of using the skilled labour on the project?
Solution:
Contribution per hour lost from normal working : $3
Add back: labour cost per hour which is not saved : $4
Cash lost per labour hour as a result of the labour transfer : $7 (total)
The contract should be charged with 5,000 × $7 = $35,000
When I went through the lecture, I’ve learnt that the labour cost which is supposed to be incurred anyway is not relevant but anything extra would be relevant. But in this question labour is transferred from normal working is considered relevant which I think is probably incorrect? Could you kindly help me please?
Thank you so much
The answer is correct. Let me explain with a little example.
Suppose that the product currently being made has a selling price of $20, labour of $4, and other variable costs (material and overheads) of $13. It take 1 hours to make each unit.
So the contribution is $3 per unit.
Suppose the labour is now taken to be used on a new product.
For every hour taken for the new product, it means 1 unit of the current product cannot be made.Therefore they will lost revenue of $20, but they will save the materials and overheads of $13. (the labour will still be paid).
So the net loss is 20 – 13 = $7 per hour.
(This is always the same as the contribution ($3) plus the labour ($4) )I hope that makes sense 🙂
I am gradually understanding the concept of relevant costing. I’ve understood the calculations when labour costs would be considered relevant. You make everything look very easy.
I’m almost about to complete this chapter because of your lectures Sir.
But I am a bit confused as to why labour costs would be considered relevant if supervisor’s normal cost was not considered relevant?
Thank you so much. 🙂
It is because a supervisor will be paid the same amount however much work he/she is doing (unless obviously the question specifically says differently). So doing some new work doesn’t affect the total cost at all because they will be paid the same amount anyway.
Oh that’s because variable costs are relevant because it changes. And supervisor’s costs are fixed. I got it Sir.
Thank you so much Sir. 🙂
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