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Chapter 7 - Labour Costing and Control

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111 views4 pages

Chapter 7 - Labour Costing and Control

full info

Uploaded by

Naji
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER # 7

Costing and control of labour


Determining the direct labour cost that is relevant to short term decision making
depends on the circumstances. Where a company has temporary spare capacity
and the labour force is to be maintained in short term, the direct labour cost
incurred will remains the same for all alternative decision. The direct labour cost
will therefore be irrelevant for short term decision making purpose. Consider now
a situation where casual labour is used and where workers can be hired on daily
basis, a company may then adjust the employment of labour to exactly the
amount to meet the production requirement. The labour cost will increase if the
company accepts additional work, and will decrease if production is reduced. In
this situation the labour cost will be relevant cost for decision making purpose.
Scenario 1: Availability of spare capacity
This is applicable where the labor hours available exceed the labor hours currently
being utilized, i.e. spare capacity exists.
Where spare capacity is available, relevant cost is the incremental cost of utilizing
additional labor hours, i.e. variable cost of each additional hour.
Fixed costs which do not change as a result of the change in labor hours consumed
should not be considered as relevant. For instance, if direct labor is guaranteed idle
time pay equal to 60% of the normal pay during periods of lower demand, the relevant
cost of labor shall be only 40% of the normal pay because 60% of the cost will be
incurred irrespective of any additional work undertaken.
Scenario 2: Overtime and Additional Staff
When existing labor is already being fully utilized, any additional labor requirement may
be met either by offering overtime to current staff or by hiring new employees.
The relevant cost of direct labor in this scenario shall be the total cost of additional labor
hours required for the proposed business action.
Scenario 3: Divert Labor Resources
As a last preference, direct labor engaged in current production may be diverted
towards the new business proposition where no spare capacity exists and neither can
new labor be hired externally.
The relevant cost of direct labor in this scenario shall be the variable cost of labor to be
utilized plus any loss of contribution resulting from the discontinuation of current
production activities. The lost contribution represents the opportunity cost of using labor
on a new project when current production has to be sacrificed.
Indirect Labor
Indirect labor consists of employees that are not directly involved in the production such
as managerial and administrative staff.
Relevant cost of indirect labor is the incremental cost, i.e. the additional cost that results
directly from the implementation of the proposed business action.
Unlike direct labor, the cost of indirect labor is largely fixed and unaffected by variations
in output in the short term in most cases because managerial and administrative staff is
usually salaried. Therefore, for very short term decisions (e.g. pricing decisions of
special orders), the relevant cost of indirect labor would often be negligible.
Question # 1
L.W is currently deciding whether to undertake a new contract. 15 hour of labour will be
required for the contract. L.W currently produces product L, the standard cost of detail
of which are shown below.
Rs.
Direct material (10 kg @ Rs.2) 20
Direct labour (5 hour @ Rs.6) 30
50
Sales price per unit 72
Contribution 22
Required:
1. What is the relevant cost of labour if the labour must be hired from outside the
organization.
2. What is the relevant cost of labour if L.W expects to have 5 hour spare capacity.
3. What is the relevant cost of labour if labour is short supply?

Question # 2
A division of Rhine auto has received an enquiry from one of its major customers for a
special order for a component that will required 1,000 skilled labour hours. Skill labour is
currently in short supply and if the company accept the order then it will be necessary to
reduced production of component P. Detail cost per unit and selling price per unit of
component P are as follows:
Rs.
Sales price 88
Direct labour (4 hours @ Rs.10) 40
Other variable cost 12
Contribution margin 36

Required:
Calculate the relevant cost.

Question # 3

A contract is under consideration that requires 600 labour hours to complete. There are
350 hours to spare capacity.
The remaining hours for the contract can be found either by weekend overtime working
paid at double the normal rate of pay or by diverting labour from the manufacturing the
product QZ. If the contract is undertaken and labour is diverted, then sales of product
QZ will be lost. Product QZ takes three labour hours per unit to manufacture and makes
a contribution of Rs.12 per unit. The normal rate of pay of labour is Rs.9 per hour.

Required:
What is the total relevant cost of labour for the project?
Question # 4

A contract is under consideration that required 800 labour hours to complete. There are
450 hours of spare labour capacity for which the worker are still being paid the normal
rate of pay. The remaining hours required for the contract can be found either by
overtime working paid at 50% above the normal rate of pay or by diverting labour from
the manufacturing of product OT. If the contract is undertaken and labour is diverted,
then sales of product OT will be lost. Product OT takes seven labour hours per unit to
manufacture and makes a contribution of Rs.14 per unit. The normal rate of pay for
labour is Rs.8 per hour.

Required:
Calculate the relevant cost of labour to the contract.

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