2019

COST AND MANAGEMENT

ACCOUNTING
Examinable Supplement
with Questions
 Certificate in Accounting and Finance

10

CHAPTER
Cost and Management Accounting

Additional Material

Contents
Labour Costing
1 Introduction to labour costing and labour cost control
2 Management of productivity and efficiency
3 Wage incentive plans
4 Learning curve theory
5 Recording and accounting for labour cost
Process Costing
1 Cost of rework
2 Addition of materials in subsequent process

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INTRODUCTION
Learning outcomes
The overall objective of the syllabus is to equip candidates with techniques of cost
accounting to provide a knowledge base for decision making skills.
LO2 On the successful completion of this chapter, candidates will be able to
demonstrate an understanding of different costing systems
LO 1.9.1 Discuss productivity and efficiency measurement in relation to controlling
labour costs
LO 1.9.2 Explain the concept of remuneration systems, incentive wage plans and types
therein
LO 1.9.3 Record labour costs
LO 1.9.4 Apply the impact of learning curve theory on the productivity of employees
LO 2.5.4 Account for the cost of rework
LO 2.5.5 Account for the units added in subsequent departments

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Labour Costing

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1 INTRODUCTION TO LABOUR COSTING AND LABOUR COST CONTROL

Section overview

 Introduction
 Measuring labour activity
 Labour payment methods
 Basis of labour cost control

1.1 Introduction
Labour cost is the second important element of the cost of production after
material cost. Labour costs constitute a major portion of the total cost of a
product or service that may take the form of wages, salaries and/or other
incentives of employee remunerations. The profitability and growth of the entity
depends greatly upon the proper utilization of the human resources that in turn
needs to be properly recoded and controlled.
Types of labour cost:
The labour cost has two types:
 Direct Labour Cost: Direct labour cost is any cost that is specifically
incurred for or can be readily charged to or recognized with any specific
contract, job or work order. In cost accounting it is classified as direct
labour cost which becomes part of prime cost.
Example: In a watch manufacturing factory, a worker operating a molding
machine to produce a part of wrist watch.
 Indirect Labour Cost: Where the direct labour can be recognized with and
charged to the job, the indirect labour cannot be so charged and hence is
treated as part of the factory overheads.
Example: Wages paid to supervisor of a factory or salary paid to driver of
delivery van used for distribution of the product.
Wage payments are generally based on the productivity, time and skill or the
combination of these three. Proper control and accounting for this cost factor and
motivation of worker is important in bringing efficiency to an enterprise.

Example:
 Wage payment based on productivity: Wages paid on the basis of number of
units produced, like stitching 2000 pieces of shirts at Rs. 75 per piece.
 Wage payment based on time: Wages paid on the basis of number of hours
a worker worked in a production line, like 160 hours paid at Rs. 175 per
hour.
 Wage payment based on skill: A wage differentiation due to varied skills,
like skilled workers are paid higher than apprentice for the same job.

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1.2 Measuring labour activity

It is important to differentiate between “production” and “productivity” while
measuring labour activity.
 Production: Production refers to the quantity or volume of the output
produced i.e. the total number of units produced. Production therefore is a
measure of quantity of work.
 Productivity: Productivity unlike production is a measure of efficiency with
which the units have been produced.

Example:
Mr. X is supposed to produce six units in every hour at work. The standard
productivity rate is six units per hour for every employee. During the week he
made 252 units in 38 hours of work. The productivity ratio is worked out as:
The total production in the week is 252 units.
Productivity is a relative measure of the hours actually taken and the hours that
should have been taken to make the output.
It might be determined in either of the following two methods
Method 1:
252 units should take 42 hours
But took 38 hours
Productivity ratio = 42/38 x 100 110.5%
Method 2:
In 38 hours Mr.X should make 228 units
But made 252 units
Productivity ratio = 252/228 x 100 110.5%
Comment: A productivity ratio greater than 100% indicates that the actual
efficiency is better than the standard or expected level of efficiency.

1.3 Labour payment methods

The choice of appropriate labour payment method is very important for any
organisation as it:
 may affect the cost of the finished products specially when it is a labour
intensive organisation,
 casts a major impact on the morale and efficiency of the employees and
serious consideration should therefore be given to the possible motivational
impact of the remuneration method being adopted.
The two widely known basic labour payment methods are:
 Time rate
 Piecework

Time rate
Time rate/ time work or basic pay is where the employee gets paid on the basis
of his time spent at work. The most common form of this type is a day-rate
system.

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The formula used for calculating wages under this method is:
Wages = Hours worked x Per hour pay rate
 Overtime: If an employee works for more hours than the basic daily
requirement or on days which do not constitute a part of the working week
(e.g. Saturdays and Sundays), then he may be entitled to an overtime
payment. The overtime hours are usually paid at a premium rate such as
“time and a quarter”, “time and a half” or “double-time”.
Time and a quarter for example, means that 1.25 times the basic hourly
rate is paid for hours worked in excess of the basic requirement. The
overtime premium is the extra rate paid over and above the basic rate.
If employees work unsocial hours, e.g. overnight, then they are entitled to a
shift premium which is quite similar to an overtime premium and means that
the employees are paid at an increased hourly rate.

Example:
If the basic rate of pay per hour is Rs. 6 and overtime rate is time and a half, then
calculate the overtime premium for 8 hours worked in excess of the basic
requirement.
Solution:
Rs.
Basic Pay (8 x Rs. 6) 48
Overtime premium (8 x Rs. 3) 24
Total (8 x Rs. 9) 72

Piecework
Under this method the employee is paid an agreed amount for each unit of output
completed or for each task carried out. Output units per hour may also be an
agreed upon number that is referred to as “standard hour produced”. It is also
normal under piecework scheme that the employees get a guaranteed minimum
wage regardless of the number of units produced. This safeguards them from
loss of earnings when the production is low and is not on account of their own
fault.
The wages under the piecework system can be calculated as:
Wages = Units produced x Per unit pay rate

Example: Straight piecework with guaranteed minimum wage

Sara is paid Rs. 20 for each unit produced with a guaranteed wage of Rs. 2000 for
a 40 hour week. For a series of 4 weeks of the month she produced 140, 160, 180
and 200 units. Calculate total amount for the month.
Solution:
Rs.
Week 1 [(140 units x Rs. 20) + Rs. 2000] 4,800
Week 2 [(160 units x Rs. 20) + Rs. 2000] 5,200
Week 3 [(180 units x Rs. 20) + Rs. 2000] 5,600
Week 4 [(200 units x Rs. 20) + Rs. 2000] 6,000
Total for the month 21,600

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1.4 Basis of labour cost control

Labour cost control requires analysis of labour cost with different angles and
perspectives, such as, cost per hour, cost by departments, by product lines, by
direct and indirect angle, by rates, by jobs or processes.
Labour cost controls aim to achieve maximum efficiency without compromising
the quality and effectiveness of the operations. Cost analysis and wage system
help in achieving this objective.

Example:
ABC Publishers Limited pays wages to workers working on book binding machine
at the rate of Rs. 17 per book. Workers are not paid for the misaligned binding and
such book is scraped for Rs. 15 per kg. The policy motivates the workers to work
hard and maximize productivity. However, the rate of wastage in ABC is 3% as
against industry average of 1%.
ABC re-visited the wage policy and felt that it is likely that workers tend to
compromise the quality because of insignificant loss they suffer due to bad quality.
It intends to bring a policy whereby a deduction of Rs. 70 will be made from the
wages for each misaligned binding beyond 1% industry average. However, it is
estimated that such policy will reduce the efficiency of workers because they would
reduce the speed to achieve desired quality benchmark and avoid deduction.
The cost controller of ABC is supposed to work out the differential cost and revenue
to evaluate the policy before implementation. For this purpose, cost controller
needs precise data with reasonable accuracy about the machine capacity, labour
related wastage, impact of slow speed and contribution margin per unit.

Effective labour cost control is achieved through different tools including;

 analyzing the targeted production,
 preparing labour budget and standardizing labour cost per unit,
 monitoring output, quality, wastage ratios, rework cost due to bad
workmanship
 wage incentive systems.

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2 MANAGEMENT OF PRODUCTIVITY AND EFFICIENCY

Section overview

 Introduction
 The importance of measuring productivity and efficiency

2.1 Introduction
Labour productivity can be described as a ratio between labour hours and units
produced. Labour efficiency measures how efficiently workers produce a given
quantity of units. Productivity can be stated in one figure, such as; in Engine
Installation Department 3 units per 8 labour hours is the productivity of the
department. In assessing efficiency a single figure would not suffice. There
should be any comparable figure, like own historical data, industry average or
budgeted productivity.

Example:
Waqas Motors Limited achieved 3 units per 8 labour hours productivity in 2015-16
in Engine Installation Department as against 2.8 units per 8 labour hours in 2014-
15. The department efficiently utilized its human resources in the year 2015-16 as
compared to 2014-15
Efficiency is achieved through high motivation and skills of workers and by better
processes and quality of machines and tools. Improved productivity positively
impacts the business profits and the earnings of workers.
It may be noted that productivity and efficiency measures generally indicate
number of output as against the labour input and do not usually refer to the quality
and level of bad workmanship. The quality aspect is also important to achieve the
objectives of cost controls.

2.2 The importance of measuring productivity and efficiency

In a competitive business environment where the price of a product is difficult to
be controlled by the producers, the efficient utilization of resources is the key.
Labour cost in many industries is so significant that its efficiency can make the
difference. A producer should be able to set standards of performance in terms of
hours and cost per hour or cost per unit of production.
The performance standards measure the performance in unit and rupee term and
variances help the managers to focus around the problem areas.

Example:
In a production department the performance standards for a production of 3,000
units are set as 2,000 hours at Rs. 90 per hour. If 2,200 hours are used at standard
rate of Rs. 90 per hour to produce 3,000 units then there is an unfavourable labour
efficiency ratio of 90.9% (2,000 /2,200). In rupee term the unfavourable variance
is Rs. 18018 computed as (100%-90.9%) * 2,200*90.

There can be a variance as against the performance standards, which arises due
to difference in wage rates. Therefore, a total variance between the performance
standards and actual results is analyzed in a way that we arrive at the break up
of both variances, namely, labour efficiency variance and labour rate variance.

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Example:
In a production department the performance standards for production of 3,000
units are set as 2,000 hours at Rs. 90 per hour. If 2,200 hours are used at Rs. 85
per hour to produce 3,000 units, the analysis of variance is as follows:
Actual 2,200 labour hours at Rs.85 per hour Rs.187,000
Standard 2,000 labour hours at Rs.90 per hour Rs.180,000
Total variance (unfavourable) Rs. 7,000
Labour rate variance
Actual 2,200 labour hours at Rs.85 per hour Rs.187,000
At standard rate 2,200 labour hours at Rs.90 per hour Rs.198,000
Variance (favourable) Rs. 11,000
Labour efficiency variance
At standard rate 2,200 labour hours at Rs.90 per hour Rs.198,000
Standard 2,000 labour hours at Rs.90 per hour Rs.180,000
Variance (unfavourable) Rs. 18,000
Net (unfavourable) Rs. 7,000
The above analysis shows the importance of proper analysis before reaching to any
conclusion about the efficiency of labour force.

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3 WAGE INCENTIVE PLANS

Section overview

 Introduction
 High day-rate system
 Individual bonus schemes
 Group bonus schemes
 Profit sharing schemes
 Share incentive schemes

3.1 Introduction
In general, bonus/incentive schemes initially had been introduced for workers
who had been working under a time-based system, in order to compensate them
for their inability to increase their earnings. Wage incentive plans refer to
performance linked compensation paid to improve motivation and productivity.
Incentive schemes may either be short-term or long-term schemes.
Bonus systems base workers’ earnings on a combination of extra time served
and work done. The indirect labour is usually paid on a weekly or monthly basis,
such wages and salaries may also be increased by bonus payments.

Amount of work
Time taken done

Bonus
system

Time Piecework
Time allowed for
rate rate
actual output

Characteristics of bonus systems

 A target is set and the performance is matched against that target.
 Employees feel trusted and motivated, the productivity increase and they
are paid more for their increased efficiency.
 Despite of the organization’s labour cost being increased in terms of bonus
payments, the total unit cost of the output stands reduced and the profit per
unit of sale is increased.
The widely known bonus/ incentive schemes are discussed in the following
paragraphs.

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3.2 High day-rate system

Under a high day-rate system employees get paid at a higher than average
hourly rate provided they agree to produce a given amount of product at a given
quality.

Example: High day-rate system

Shahid makes 200 units in a 40 hour week if he were to be paid Rs. 4 per hour,
but 240 units if he were paid Rs. 5 per hour.
Calculate
i. the amount to be paid to Shahid in both the cases,
ii. labour cost per unit
iii. cost per unit of output if the production overhead is recorded at the rate
of Rs. 4 per direct labour hour.
Solution:
Rs.
i. Amount to be paid to Shahid
a. Under low day-rate scheme
40 hours x Rs. 4 160
b. Under high day-rate scheme
40 hours x Rs. 5 200
ii. Labour cost per unit
a. Under low day-rate scheme
(40 x 4)
200
0.8/unit
b. Under high day-rate scheme
(40 x 5)
240 0.833/unit
iii. Cost per unit
c. Under low day-rate scheme
(40 x 8)
200
1.60/unit
d. Under high day-rate scheme
(40 x 9)
240
1.5/unit
Comment:
Though in the given example the labour cost per unit is lower under the low day-
rate scheme but the total unit cost is lower under the high day-rate scheme.
Therefore we see that the high day-rate scheme in the given scenario would
reward both i.e. the employer (a lower unit cost by 10p) and employee (an extra
Rs.1 earned per hour).

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Advantages
 It is easier to calculate and understand.
 It assures the employee a consistently high wage.
Disadvantages
 Employees cannot go beyond the fixed hourly rate for the extra effort they
put in. In the example given above if the employee makes 280 units instead
of 240 units in a 40 hours week, the cost per unit would decrease even
further but all the savings would go to the benefit of the employer and none
would go to the employee.
 The high wages might become the accepted wage level for normal working.
Management might need to keep checks on the productivity and efficiency
levels of the employees.

3.3 Individual bonus schemes

An individual bonus scheme sets out performance objectives/targets and usually
forms part of the performance appraisal systems of organizations. Every
individual’s bonus is calculated separately and is unique to every employee. So
basically it is an incentive whereby an employee has to qualify to be entitled for a
bonus on top of his/ her basic wage.
For Example, Rs.100 per unit bonus is paid to an employee if he produced at
least 500 units per month. If an employee achieves that performance standard
then he will be entitled to get a bonus on all units produced.

3.3 Group bonus schemes

In cases where individual efforts cannot be exactly measured and employees
work as a team, individual incentive schemes become impracticable. In such
scenarios group incentive schemes are found to be more relevant and feasible.
Even in cases where an individual alone cannot complete his job without the
cooperation of his fellow workers, there too, group incentive schemes are given
preference over the individual bonus schemes.
Group bonus plans reward all team members equally based on overall
performance of the team members. It usually comes into play when individual
output cannot be measured with accuracy. Therefore, team performance is
evaluated on the basis of time taken to complete the job rather than output
produced. Usually, the bonus earned by the group is divided among the group
members in accordance with their respective base rates.
For Example, a bonus may be paid to department which has a reject rate in unit
of output below a specified ratio in proportion to their respective basic wages.
Advantages
 Group schemes reduce the clerical efforts to be put in for the calculations of
individual incentive schemes.
 They are easy to be administered.
 Group schemes improve the team cohesion.
Disadvantages
 Employees might demand for minimum targets for accepting the scheme.
 Employees doing the best and the worst might fall victim to team’s politics.

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3.4 Profit sharing schemes

A profit sharing scheme offers the employees a certain proportion of the
organization’s profits. The size of this offer is related to the designation of the
employee and also the length of the employment period to date.
Advantages
 The biggest advantage is that the organization will pay only what it can
afford to pay out of the actual profits earned.
 Such schemes can be offered to indirect labour as well.
Disadvantages
 Employees may be putting in best of their efforts yet the organization might
still incur losses on account of issues beyond the control of the employees.
 It is a long term commitment that the organization is asking for. The
employees have to wait for the bonus until the year ends. The reward is not
an immediate one.

3.5 Share incentive schemes

A share incentive scheme is where the employees of the company are given an
option to acquire the shares as an incentive. In this way the employees’ morale
rises so does their loyalty due to the feeling that they now have a stake in the
company they work for.

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4 LEARNING CURVE THEORY

Section overview

 The learning effect

 Learning curve explained

4.1 The learning effect

Learning is the process by which an individual acquires skill, knowledge and
ability. When a new product or process is started, the performance of the worker
is relatively low since the job has just recently started but if it is fairly repetitive in
nature then the learning phenomenon takes place. When the experience is
gained, the worker is likely to become more confident and knowledgeable about
the task thus the performance improves, which in turn reduces the time taken per
unit and increases the productivity.
The effect that learning casts on employees, can be represented by a line called
a learning curve. It displays the relationship between the production time per
unit and the cumulative number of units produced. Learning curve has a direct
impact on direct labour wages.
Eventually when the worker has had enough experience and nothing more is left
for him to learn, then the learning process stops i.e. the learning would stop after
a certain time limit and beyond specific number of units produced.
Assumptions
 The amount of time required to complete a unit of a product or a given task
will decrease every time the task is undertaken.
 the unit time will decrease at a decreasing rate, and
 The time reductions will have a predictable pattern.

4.2 Learning curve theory

The learning curve theory refers to the phenomenon that the cumulative average
time required per unit will decrease by a constant percentage every time total
output of the product doubles. Doubling of output is an important part of the
measurements determining the learning effect.
For example if we take the example of the 80% learning effect, the cumulative
average time required per unit is reduced to 80% of the previous cumulative
average time when the output is doubled. Note that the cumulative average time
is the average time per unit for all units produced till now, inclusive of the first unit
made.

Example: The 70% learning effect

If the first unit of output requires 100 hours and a 70% learning effect occurs, then
determine the production times for:
 Total production
 Incremental total hours
 Incremental hours per unit

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Cumulative
Cumulative avg.
no. of units Total Time Incremental time
time/unit
produced
Total time Time per unit
Hours Hours Hours Hours
1 100.0 (x1) 100
2 (70%) 70.0 (x2) 140 40 ÷1 40
4 (70%) 49.0 (x4) 196 56 ÷2 28
8 (70%) 34.3 (x8) 274.4 78.4 ÷4 19.6

Formula
The learning curve formula, is shown below,
b
Y = ax
Where Y = cumulative average time per unit to produce x units
a = the time taken for the first unit of output
x = the cumulative number of units produced (output)
b = the learning curve factor (i-e. log LR/log2)
LR = the learning rate as a decimal

Example: Formula for the learning curve

Find the value of b when a 90% learning curve effect takes place.
Solution:
b = log 0.9/log 2
= -0.0458/0.3010
= -0.152

Example: Learning curve

Quality Plastics Limited (QPL) produces plastic bodies of various appliances
according to the customers’ specifications. It has received an order for supply of
10,000 plastic bodies of a washing machine. The supply is to be made within 30
days.
The following information is available:
(i) QPL carries out production process in batches of 100 units each. Cost of the
first batch is estimated as under:
Rupees
Direct material (inclusive of 10% input losses) - 1,100 kg 66,000
Direct labour cost at normal rate - 200 hours 44,000
Overheads at normal rate 200 hours 30,000
(ii) It is estimated that due to learning curve effect, completion of the first,
second, third and fourth batch would require 200, 160, 148 and 140 hours
respectively.

This learning effect would continue till completion of 64 batches only.

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Learning effect at various learning levels is as under:

80% 85% 90%
–0.322 –0.235 –0.152
(iii) It is estimated that after completion of the first 16 batches, material input
losses would be reduced from 10% to 6%.
(iv) QPL works a single shift of 8 hours per day. For the above order, QPL can
spare 8,000 direct labour hours. Overtime hours can be worked at 1.5
times the normal rate. During the overtime hours, overheads would be 1.25
times the normal rate.
Required:
Compute the price that QPL should quote in order to earn a margin of 25% of the
selling price.
Solution:
Material Rs.
First 16 batches (16*66,000) 1,056,000
Next 84 batches 84*(66,000/1.1*1.06) 5,342,400
Direct labour cost
Normal hours at Rs. 220 1,760,000
Overtime hours at Rs. 330 686,070
Overheads
Normal hours at Rs. 150 1,200,000
Overtime hours at Rs. 187.5 389,813
Total costs 10,434,283
Order price at a margin of 25% of the selling price 13,912,377

W.1: Learning curve %:

Batch No. Cumulative hours Average hours per Learning
batch curve %
1 200.00 200.00
2 (200+160) 360.00 180.00 (180/200)
90%
4 (360+148+140) 648.00 162.00 (162/180)
90%
Hours for first 64 batches 64*200*(64)-0.152 6,803
Hours for first 63 batches 63*200*(63) -0.152 ( 6,712)
Hours per batch after 63rd batch 91
Hours required:
First 64 batches 6,803
Last 36 batches (91×36) 3,276
Total hours 10,079
Overtime hours (10,079 – 8,000) 2,079

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5 RECORDING AND ACCOUNTING FOR LABOUR COST

Section overview

 Recording labour costs

 Journal entries for recording labour costs

5.1 Recording labour costs

There are various departments within an organisation that are involved in
collecting, recording and costing of labour. The procedures involve production
planning, time and motion study, timekeeping, labour budgeting, etc. A brief
detail of the departments involved and procedures performed by them in the due
process is produced below.
Human Resource department
The HR department is primarily responsible for the hiring of employees, engaging
them, their transfer, departure and termination etc. This department maintains
employees’ records and issues the reports for the management to facilitate the
decision making process of HR related issues.
Production Planning department
The Production Planning department schedules work, issues the job orders to
production departments and chases up jobs in the factory when they run late.
Time keeping department
The timekeeping department keeps track of the time spent in the factory by each
worker and the time spent by each worker on each job.
The time keeping activity might be carried out using any of the following tools
with reference to the relevance and importance to the nature of activity.
 Daily time sheets: The daily time sheet is filled in by the employee on
everyday basis. It will record how his/ her time in the factory has been
spent. The total time on the sheet should however correspond to the record
on the attendance form.
 Weekly time sheets: They are similar to the daily time sheets but are sent
to the cost office towards the end of every week.
 Job cards: Job cards are job specific and are prepared for every job or
batch separately. In a time sheet the worker if engaged with many jobs will
have several entries related to the respective jobs wherein in case of job
cards, each job card will contain the detail of activities carried out by the
employee in respect to that specific job only.
 Piecework or operation card: a Piecework ticket contains the record of
total number off items produces by the employee and the total number of
the units rejected. Payment would be made for only the items that are as
per the required standards.
Cost accounting department
The cost accounting department accumulates and classifies all the data related
to the labour costs. The information is then shared with the management to help
determine the control measures if required.

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5.2 Journal entries for recording labour costs

The primary journal entry for payroll is the summary-level entry that is compiled
from the payroll register and which is recorded in either the payroll journal or the
general ledger. This entry usually includes debits for the direct labour expense,
salaries and the company's portion of payroll taxes. There will also be credits to
the liability for payroll taxes that have not been paid, as well as for the amount of
cash already paid to employees for their net pay. The basic entry (assuming no
further breakdown of debits by individual department) is:

(i) To record the total wages earned

Debit Credit
Payroll xxx
Accrued Payroll tax xxx
Payroll advances xxx
Payroll deductions xxx
Accrued Payroll xxx
(ii) To record payment of the payroll
Debit Credit
Accrued Payroll xxx
Cash/Bank xxx
(iii) To record the closure of the Payroll account
Debit Credit
W-I-P – Direct Labour xxx
FOH – Indirect Labour xxx
Selling Expenses Control a/c – Sales Salaries xxx
Administrative Exp – Office Salaries xxx
Payroll xxx

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Process Costing

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1 COST OF REWORK
Section overview

 Normal Rework
 Abnormal Rework

Sometimes the loss incurred in processing is not scrapped but is subject to a further
rectification process, this extra processing cost is referred to as rework.

Rework might be performed on units that are either classified as normal or abnormal
loss:

1.1 Normal Rework

The rework cost is charged to the normal processing cost. Rework may involve
some material use, labor use etc. Hence the entry is:

Debit Credit
Process account X
Materials Account X
Direct Labour Account X

1.2 Abnormal Rework

Abnormal rework is not charged to process account so that that it will not appear
in future estimates for similar jobs. It is recorded in a separate loss account:
Debit Credit
Loss from Abnormal Rework account X
Materials account X
Direct Labour account X

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2 ADDITION OF MATERIALS IN SUBSEQUENT PROCESS

Section overview

 Introduction

Introduction
Many industries that utilize process costing have more than one processes through
which the units pass through before being turned into finished goods e.g. In oil refining
the crude oil passes through distillation, reforming, isomerization etc. before turning
into a final finished product.
As the production passes through different products, the finished goods output of one
process becomes the raw materials input of the next process, in addition to the units
from the previous process, new materials may also be added in the next process. In
order to separately distinguish the costs incurred in different processes or department
the cost from the previous process are labelled as “Direct Materials – Process 1”.

Example:
Description Process X Process Y
Materials Added (KGs) 10,000 2,000
Materials (Rs.) 30,000 3,000
Direct Wages (Rs.) 16,000 40,000
Production OH as % of Direct Wages 25% 30%
Normal Loss% 5% 5%
Materials Output (KGs) 9,500 10,925

Process 1 A/c
KGs Rs. KGs Rs.
Direct Normal
Materials 10,000 30,000 Loss 500
Output to
Direct Wages 16,000 Process 2 9,500 50,000

Production OH 4,000
10,000 50,000 10,000 50,000

Process 2 A/c
KGs Rs. KGs Rs.
Direct
Materials - Normal
process 1 9,500 50,000 Loss 575
Direct
Materials 2,000 3,000 Output 10,925 105,000

Direct Wages 40,000

Production
OH 12,000
11,500 105,000 11,500 105,000

21 The Institute of Chartered Accountants of Pakistan

Cost and management accounting Examinable Supplement - 2019

22 The Institute of Chartered Accountants of Pakistan

Labour Costing Examinable Supplement - 2019

Questions & Answers

23 The Institute of Chartered Accountants of Pakistan

Cost and management accounting Examinable Supplement - 2019

24 The Institute of Chartered Accountants of Pakistan

Labour Costing Examinable Supplement - 2019

QUESTIONS
1 Question # 1
IB Company, a manufacturer and supplier of specialized equipment, is currently
engaged in producing the new equipment.
The company has been producing 150 units per week of new product; factory overhead
(all fixed) was Rs.12,000 per week. The following is a schedule of the pay rates of
three workers.

Employee Hourly Rate

Sami Rs.60
Ali Rs.80
Pervaiz Rs.70

Customers have been calling in for additional units but management does not want to
work more than 40 hours per week. To motivate its workers, the company decided to
introduce an incentive wage plan. Under the plan, the workers would be paid a base
rate per hour, as shown in the following schedule, and a premium of Rs. 10 per unit
when the total number of units exceeds 150.
Employee Base Rate
Sami Rs.35
Ali Rs. 55
Pervaiz Rs. 45

As a result, production increased to 165 units. The supervisor studied the results and
considered the plan too costly; production has increased 10%, but the labour cost has
increased by approximately 23.2%. The supervisor requested permission to redesign
the plan in order to make the labour cost increase proportionate to the productivity
increase.
Required:
1. The Rupees amount of the 23.2% labour cost increase.
2. An opinion, supported by figure, as to whether the shop supervisor was correct in
assuming that the incentive wage plan was too costly, and a discussion of other
factors to be considered.

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Cost and management accounting Examinable Supplement - 2019

2 Question # 2
Standard production for an employee, Tayyab, in the Assembly department of
Moazzam Ltd. is 20 units per hour in an 8-hours day. The hourly wage rate is Rs.75.
Required:
Tayyab’s earning under each of the following condition
1. If an incentive plan is used, with the worker receiving 80% of the time saved each
day and record indicate:

Day Unit Hours Day Unit Hours Day Unit Hours

Monday 160 8 Tuesday 170 8 Wednesday 175 8

2. If the 100 percent bonus plan is used and 880 units are produced in a 40-hour
week.
3. If an incentive plan is used, providing an hourly rate increase of 5% for increase of
5% for all hours worked each day that quota production is achieved and records
indicate:

Day Unit Hours Day Unit Hours Day Unit Hours

Monday 160 8 Tuesday 170 8 Wednesday 175 8

3 Question # 3
Group bonus plan
Employees of Abdullah Enterprises work in groups of five plus a group leader.
Standard production for a group is 400 units for a 40-hour week. The workers are paid
Rs.60 an hour until production reaches 400 units then a bonus of Rs.120 per unit is
paid with Rs.100 being divided equally among the five workers and the remainder
passing to the group leader (who is also paid a weekly salary of Rs.3,000). Factory
overhead is Rs.60 per direct labour hour and includes the group leader's earnings.
The production record of a group for one week shows:
Hours worked Units produced
Monday 40 72
Tuesday 40 81
Wednesday 40 95
Thursday 40 102
Friday 40 102
Total 200 452
Required
1. The week’s earnings of the group (excluding the leader), the labour cost per unit,
the overhead cost per unit and the conversion cost per unit, based upon the above
data.
2. A schedule showing daily earnings of the group (excluding the leader), unit labour
cost, unit overhead cost, and the conversion cost per unit, assuming that the
company uses the group bonus plan.

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Labour Costing Examinable Supplement - 2019

ANSWERS
1 Answer # 1
1. Regular Work Week
Employee Hourly Work Total Base Pay Incentive Pay Total
Rate Week Labour (Base Rate x (Units Produced Labour
(Rs.) Cost Work Hours) x Incentive Cost
(Rs.) Premium) (Rs.)
(Rs.)
(Rs.)
Sami 60 40 hrs. 2,400 35x40 hrs. = 165 x 10 = 1,650 3,050
1,400
Ali 80 40 hrs. 3,200 55x40 hrs. = 165 x 10 = 1,650 3,850
2,200
Pervaiz 70 40 hrs. 2,800 45x40 hrs. = 165 x 10 = 1,650 3,450
1,800

Total direct Labour Rs.8,400 Total direct Labour Rs.10,350

Rs.10,350-Rs.8,400=Rs.1,950 Proof Rs.1,950/8,400=23.2%

labour cost increase Labour increase

2. To assess properly the effectiveness of the new plan, it is necessary to analyze its
effect on conversion costs and not just on direct labour cost. Although direct labour
cost unit may rise, this increase may be more than offset by distributing the
overhead over a large volume.
A comparison of the two pay plans and their effects on conversion cost per unit
shows:
Total Labour Total Overhea Total Unit
Labour Cost per factory d per Convers Convers
Cost unit overhea unit ion Cost ion Cost
(Rs.) (Rs.) ds (Rs.) (Rs.) (Rs.) (Rs.)
Incentive wage 10,350 62.8 12,000 72.7 22,350 13.55 *
plan
Straight Hourly 8,400 56.0 12,000 80 20,400 13.60 **
Rate
Difference 6.8 (7.3)
(0.50)

* Rs. 22,350 / 165 units = 13.55 / unit

** Rs. 20,400 / 150 units = 13.60 / unit
The decrease in conversion cost is minimal: however, the fact that customers can
be served sooner might be worth the additional labour cost. Bases on learning curve
theory, the productivity of the worker might increase sufficiently to reach a
satisfactory output and cost level.

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Cost and management accounting Examinable Supplement - 2019

2 Answer # 2
1.

Monday Tuesday Wednesday

Hours x Hourly Rate [Rs.75/hour*8 hours) - Rs.600 Rs.600 Rs.600

A

Units above standard - 10 15

Hours saved (10/20 and 15/20) - 0.50 0.75

Value of time saved (wage rate / hour x - Rs.37.5 Rs.56.25

hours saved)

80% of value of time saved - B - Rs.30 Rs.45

Earning (A+B) Rs.600 Rs.630 Rs.645

2. Earnings= *110% x Rs.75 hourly rate x 40 Hours = Rs.3,300

(*Efficiency ratio = 880 unit (actual)/800(normal) =110%)
3. Earnings => Rs.75 hourly rate * 5% rate increase x 24 Hours = Rs.189

3 Answer # 3
1.

Hours Worked (5 Workers x 40 Hours) 200

Regular Wage (200 Hours x Rs.60) - A Rs.12,000

Units Produced – B 452

*Bonus – C Rs.5,200

Weekly earnings (A+C=D) Rs.17,200

Unit Labour Cost (D/B=E) Rs.38.05

Unit factory overhead (A/B=F) Rs.26.55

Unit conversion cost (E+F) Rs.64.6

*Bonus
452 units produced
400 units standard
52 units above standard x Rs.100 workers share = Rs.5,200

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Labour Costing Examinable Supplement - 2019

2. ABDULLAH ENTERPRISES
Monday Tuesday Wednes Thursday Friday Total
day
Unit produced 72 81 95 102 102 452
Standard Hours 36 40.5 47.5 51 51 226
for unit produced
(W1)
Actual Hours 40 40 40 40 40 200
Bonus, Rs.60 x -- Rs.30 Rs.450 Rs.660 Rs.660 Rs.1,800
hours saved
Total earnings Rs.2,400 Rs.2,430 Rs.2,850 Rs.3,060 Rs.3,06 Rs.13,800
0
Unit Labour Cost Rs. 33.33 Rs.30 Rs.30 Rs.30 Rs.30 Rs.30.53
(W2)
Unit Factory Rs. 33.33 Rs.29.6 Rs.25.3 Rs.23.5 Rs.23.5 Rs. 26.55
overhead (W2)
Unit conversion Rs. 66.67 Rs.59.6 Rs.55.3 Rs. 53.5 Rs.53.5 Rs.57.1
cost
W1
400 units per 40 hours= 10 units per hour
10 units per hour / 5 workers = 2 units per hour per worker
72 units produced / 2 units per hour= 36 hours standard time
W2
If the group bonus is computed for the week rather than daily, the bonus would be
Rs.60 x 30 hours saved = Rs. 1,800. Then per unit labour cost is Rs. 30.53
(Rs. 13,800/ 452 units) and per unit overhead cost would be Rs. 26.55
(Rs. 12,000/452 units)

29 The Institute of Chartered Accountants of Pakistan

Cost and management accounting Examinable Supplement - 2019

30 The Institute of Chartered Accountants of Pakistan

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2019

COST AND MANAGEMENT

ACCOUNTING
Examinable Supplement
with Questions