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Hi John,
I saw one question as below:
A plc is decisding whether undertake a new contract. 15 hours of labour are required for the contract. Labout is currently at full capacity producing X.
Cost card for X:
direct material (10kg@$2) $20
directo labour (5hours @$6) 30selling price $75
contribution $ 25Asking for the relevant cost. The answer is: $6 x 15 + 15/5 x 25 = $165
My question is:
If the labour is hired at the permenant basis, the “direct labour” would be paid anyway either for X or this new contract, why here the labour cost would be added to the relevant cost for new project?Thank you for your time looking at this!
Let me explain with a simple example:
Suppose the existing project has a selling price of $20, labour of $5, and other variable costs (materials and overheads) of $6. So the contribution is $9.
If the labour is taken away from this project, then we lose the selling price of $20 and we save the other variable costs of $6. (The labour is still being paid). Therefore the net loss is $14 and this is the relevant cost. This is always equal to the contribution ($9) plus the labour ($5).
Sorry, I should reply here:
Thanks John, so should it be seen as whatever is not saved, then it becomes a relevant cost for new project?
If under the situation that the labour is in spare capacity, the relevant cost is none. But the labour pay is not saved as well, why it is not a relevant cost? I mean, under both situations (spare capacity and no-spare capicity), the labour pay is not saved in both. This makes me confuse.
When there is spare capacity of labour, then currently they are only paying for the labour that is being used.
If they then do another project, it means they will have to pay for more labour which means that the labour is then a relevant cost of the new project (and the contribution that they are currently earning is not affected by doing the new project).
Have you watched my free lectures on relevant costing? The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
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