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Hi just a quick question on item 5 machine overheads.
The solution says that all of the machine overheads of 6000 hours @$3 per hour are relevant plus the opportunity cost of the 2000 @$2 per hour lost are relevant. My perception was that the 2000 part of the 6000, ie at $3 per hour was not relevant as it would have been spent anyway on the other job and the only relevant part was the contribution lost @$2 per hour, ie, total relevant cost 4000hrs @$3 not otherwise incurred plus 2000@$2 contribution lost =$16000?
Please let me know if my understanding is incorrect
Many thanks
Hugh
No you are not correct, sorry.
We both agree on the 4000 hours @ $3. So $12,000.
As regards the 2,000 hours. If time is taken from another job then the relevant cost is always cost per hour plus contribution lost per hour i.e. 2,000 x (3 + 2) = 10,000.
To explain the logic, let me invent a simple example.
Suppose the other job took 1 hour per unit. Suppose each unit earned revenue of $9, had machine time of 1 hour at $3 per hour, and had other costs of $4 per unit. So the other job is earning a contribution of 9 – 3 – 4 = $2.
If we take machine time away from the other job, then we would lose the revenue of $9, we would still be paying the $3 for machine time (so no loss or saving there), but we would no longer have the other costs of $4 (because we would not be making the units).
So we would lose 9 and save 4 – a net loss of $5.That is the logic. However for the exam you do not want to spend time thinking about the logic and so remember that if ever time is taken away from another job then the relevant cost is: cost per hour plus lost contribution per hour. (It is the same ‘rule’ whether it is machine time or labour that is taken from another job).
Thanks John I understand. the contribution of $2 incorporates the whole cost equation, where the balancing figure I need to add back (along with the contribution), ends up being our $3 costs.
I wrote this in my notes!
Opportunity cost foregone = sales lost – other costs (not incl. our costs) = our costs + contribution
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