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- June 6, 2020 at 2:03 am
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.June 6, 2020 at 10:49 am
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).June 11, 2020 at 9:46 am
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,
AnnaJune 11, 2020 at 12:13 pm
The approach for materials does not differ – it is exactly the same logic and the answer you give to your example is correct.
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