144 ACCOUNTING FOR MANAGERS
Accountants have historically considered labour that is consumed in producing
goods or services, i.e. direct labour, as a variable cost. This is because it is
expressed as a cost per unit of production, which, in total, increases or decreases
in line with business activity. However, changing legislation, the influence of
trade unions and business HR policies have meant that in the very short term,
all labour takes on the appearance of a fixed cost. The consultation process
for redundancy takes time, and legislation such as Transfer of Undertakings
Protection of Employment (TUPE) secures the employment rights of labour that is
transferred between organizations, a fairly common occurrence as a consequence
of outsourcing arrangements. Consequently, reflecting the underlying practicality,
many businesses now account for direct labour as a fixed cost.
Relevant cost of labour...................................
The distinction between fixed and variable costs is not sufficient for the purpose
of making decisions about labour in the very short term as, in that short term,
labour will still be paid irrespective of whether people are busy or occupied.
Therefore, in the short term, a business bidding for a special order may only take
into account therelevantcosts. As was seen in Chapter 9, the relevant cost is the
cost that will be affected by a particular decision to do (or not to do) something.
As decision-making is not concerned with the past, historical (orsunk) costs are
irrelevant. The relevant cost is the future, incremental cash flow that will result
from making a particular decision. This may be an additional cash payment or
anopportunity cost, i.e. the loss from the opportunity forgone. For example, in the
case of full capacity, the relevant cost could be the additional labour costs (e.g.
overtime) that may have to be incurred, or the opportunity cost following from the
inability to sell products/services (e.g. both the loss of income from a particular
order and the wider potential loss of customer goodwill).
Costs that are the same irrespective of the alternative chosen are irrelevant for
the purposes of a particular decision, as there is no financial benefit or loss as a
result of either choice. The costs that are relevant may change over time and with
changing circumstances. This is particularly so with the cost of labour.
Where there is spare capacity, with surplus labour that will be paid whether
a particular decision is taken or not, the labour cost is irrelevant to the decision.
Where there is casual labour or use of overtime and the decision causes the cost to
increase (or decrease), the labour cost is relevant. Where labour is scarce and there
is full capacity, so that labour has to be diverted from alternative work involving
an opportunity cost, the opportunity loss is relevant.
For example, Brown & Co. is a small management consulting firm that has been
offered a market research project for a client. The estimated workloads and labour
costs for the project are:
Hours Hourly labour cost
Partners 120 £60
Managers 350 £45
Support staff 150 £20