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Relevant cost - F5 Performance Management

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Relevant cost - F5 Performance Management

In performance management, when material is scarce and you can't replace it, then the relevant cost that is taken is opportunity cost alone. But when labour is scarce and you can't hire more staff, then the relevant cost that is taken is opportunity cost and the variable cost of labour. Why so?

October 26th 2014 AN ACCA USER 520 Points
Recategorized November 5th 2014 AN ACCA USER

6 Replies

+1 Vote

As per my understanding its the opportunity cost used where labour is scarce and can't hire more staff,
opportunity cost is earning capacity forgone when selecting one of the alternative project

for material which is in hand cost is already paid. (sunk cost) - irrelevant - cost already incurred before the project is selected
but for labor unlike fixed cost variable cost is paid when they are used . - relevant - cost is not incurred at the time project is selected

October 31st 2014 AN ACCA USER 8,730 Points
Selected November 4th 2014 AN ACCA USER
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Thanks for the comment Subhash. But Subhash, labour is also scarce. If I do the special project or not I will still be incurring the labour cost. So to me it looks as if that is an irrelevant cost. Hence the doubt.
October 31st 2014 AN ACCA USER 520 Points
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If the labour is in short supply, therefore fulfilling the order will require diversion of workers from normal production towards the specific order. This will lead to worker being paid extra(In case of specific overtime) which is relevant. As well as normal production being suspended for few hours (thereby leading to lost contribution which is an opportunity cost).
November 10th 2014 AN ACCA USER 150 Points
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Look at this point for labor:

For example, currently we are producing product A which has contribution (C) = Sale price - Variable cost (excluding labor) - Labor cost
After carrying the decision, we lost some of product A because of switching labor time to another product. Actually, the labor cost (if not any
extra rate paid) is unchanged! What we lost here is the sale price and what we save here is the Variable cost. Therefore, the loss we have
is (Sale price - Variable cost), which also equal Contribution + Labor cost.

So, relevant cost of labor could be calculated in 2 ways as above, and if we see it as a loss in sale + a saving in variable cost, it would be somehow easier then?

November 11th 2014 AN ACCA USER 240 Points
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Nice point Duc Vu Minh. Could you apply the same method for material as well? So for material it should be Sales price-Labor cost which also equals Contribution + Material cost. Is this correct?
November 11th 2014 AN ACCA USER 520 Points
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Hi Areeb. The relevant cost of labour, when it is scarce and you can't hire more staff and overtime is not possible, is still labour cost + opportunity cost. Duc Vu Minh came up with a good point about labour which is visible below. But I still can't get why relevant cost for material is only opportunity cost. However Subash has said that material has already been procured and hence is a sunk cost. So I think both the answers of Subash and Duc Vu Minh are good explanations.
November 11th 2014 AN ACCA USER 520 Points
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