Unskilled labour- Relevant costing

NNoah6y ago

unskilled labour hours required in a one-off contract=500hours. These are currently fully employed by Mr Smith on jobs where they produce a contribution of $2 per unskilled labour hour. Their current rate is $10 per hour, although extra could be hired at $20 an hour if necessary. The contract is to be priced on a minimum price basis. Sir the expandable text says that the answer should be $12*500=$6000. i understand that $2*500=$1000 is for lost contrn in case where the other work is stopped. So sir should not that be the only cost for unskilled labor for new contract? P.S. - because i feel the costs 10*500=$5000 be incurred whether they work as usual or whether they work in the contract.

John MoffatTutor6y ago#1

Let me explain with a little example. Suppose that the current work has a selling price of $20 per unit, a labour cost of $10 per unit, and other variable costs (e.g. materials) of $8 per units. Each unit takes 1 hours. So the contribution per unit is $2. If one hour is taken for a new contract then we lose one unit of current work. So we lose the revenue of $20. However we also save the materials etc. of $8. (We are still paying the labour, so no saving there). Therefore the net amount lost (the relevant cost) is 20 - 8 = $12. This will always be equal to the lost contribution (2) plus the labour cost (10).

Aannajour6y ago#2

Dear Sir, Thank you for this explanation Could you please also explain why the approach for materials differs: - in case of scarce material only lost contribution is taken as relevant cost. Building upon your example - the current work has a selling price of $20 per unit, a labour cost of $10 per unit, and materials of $8 (say 1 kg) per unit. So the contribution per unit is $2. Let this 1 kg of material be in stock, $8 being the purchase price. It cannot be replenished for some reason. If 1 kg of material is taken for a new contract then we lose one unit of current work: - So we lose the revenue of $20. - However we also save the labour cost of $10. - $8 aleady paid for inventory is not a future cash-flow either way - hence no difference between decision options. - Net benefit forgone is 10 (which is in turn equal to cost of material 8 + contribution 2) Thanks a lot, Anna

John MoffatTutor6y ago#3

The approach for materials does not differ - it is exactly the same logic and the answer you give to your example is correct.