Relevant Costs — OpenTuition Forums

Aanniebabe4y ago

G Co is preparing a tender for a new contract. This contract requires 600 hours of skilled labour. Skilled labour is paid at $17 per hour. There is a shortage of skilled labour, as all employees are currently fully employed in the manufacture of product H:- Selling Price $120 Skilled Labour $34 Variable costs $20 Contribution $66 What is the relevant cost of labour? Answer is $30000 I understand that if we to undertake the new contract we cannot make H, meaning that product H = labour 2 hours per unit (34/17) 300 units will be foregone therefore lost contribution is $19800 (300*66) But why are they including the labour in the calculation 600hrs at $17 I understand that they were at full capacity, but surely if we do not make one and make the other there is no extra labour needed? please help, I am misunderstanding something

John MoffatTutor4y ago#1

Let me explain with a little example. Suppose they currently make a product that takes 1 hour per unit. The selling price is $50, materials are $20, and labour is $5. So the contribution is $25 per unit. If 1 hour is taken for a new contract then they lose the revenue of $50 but the save the materials of $20. (They will still be paying for the labour). So the net amount lost (and therefore the relevant cost) is 50 - 20 = $30. This is the same (and is always the same) as the contribution ($25) plus the labour ($5).