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“A company needs 5,000 hours of labour for a contract they have been asked to quote for. The work currently being carried out by our employees is generating a contribution of $12 per hour and using them on the contract will mean taking them away from their other work. The workers are paid at the rate of $8 per hour.
What is the relevant cost of the labour required for the contract?
A) $60,000
B) $40,000
C) $ Nil
D) $100,000”The correct answer given here was D, on the basis of ($12+$8) * 5,000 hours. But in my head the $8 per hour labour rate is not a relevant cost because it would be the same irrespective of what project the workers are on, leading to my answer A (opportunity cost of lost contribution $12 * 5,000 hours).
Could somebody please explain the rationale behind the above? Thanks!
Hi, This is a common misunderstanding & for some… the only way is just to accept the rules of relevant costing:
Where there is no spare capacity in labour hours & labour must be taken away from another job then the relevant cost is equal to lost contribution + labour rate per hour *number of hours used.
This is because when you calculate the lost contribution…. you are effectively saying you will be losing the sales revenue of the job forgone… but will be at least saving the costs related costs of the job. So effectively the only loss is the lost contribution you would have earned…
Eg
Imagine the other job earns :
Sales revenue of $10
less direct material of ($7)
less direct labour ( $2)
=
CONTRIBUTION = 1However, this is forgetting that you are not saving ALL the costs of the forgone job… you will still have to pay the labour for the new job … so you add this back onto the lost contribution.
Hope this explains
Cath
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