Accounting For Labour
Introduction
Employees who agree to work shifts, in particular
different shifts over a period of time, receive extra wage
payments. These extra payments are known as shift
allowances.
Sometimes, employees may receive wages that are
directly related to the output that they produce. This is
known as output related pay.
Some employees are paid according to the number of
units of a product that they produce in a week or month.
This is known as piecework.
Guaranteed minimum payment-A minimum take home wage which is not
determined by hours worked or units produced.
Incentive (bonus) schemes-Incentive schemes can be based on an individual’s
achievement or a group of workers meeting and exceeding targets.
Guaranteed minimum pay
Direct and indirect labour
Direct labour
basic pay of direct workers (including the basic
pay for any overtime) overtime premiums when
worked at a customer’s specific request part of
the prime cost of a product
Indirect labour
basic pay of indirect workers (for example, maintenance staff, factory
supervisors and canteen staff).
indirect labour costs make up part of the overheads (indirect costs)
indirect labour costs also include the following:
overtime premiums when due to general pressures
bonus payments
benefit contributions
idle time
sick pay
time spent by direct workers doing ‘indirect jobs’
Remuneration systems
Annual salaries-Tend to be paid to management and non-production staff.
Hourly rates of pay-Many production and manual workers will be paid for every
hour that they work.
Overtime-If normal hours are exceeded it may be possible to claim a higher rate
of pay for the extra hours worked.
Overtime payment-The total amount paid for the hours worked above the normal
number of hours.
Overtime premium-The extra paid above the normal rate for the overtime hours.
The premium will be a direct labour cost if the time has been worked at a specific
request of a customer. If the extra hours are due to general pressures, the
premium will be indirect.
Piecework payments-Employees are paid per unit of output produced. This is
method of ‘payment by results’.
Time-based systems
The most common form of time work is a day-rate system
in which wages are calculated as follows: Wages = Hours
worked*Rate of pay per hour
For example, $10 per hour for a 40 hour week. Overtime is
likely to be higher e.g. time and a half. Usually paid weekly,
but may be monthly. The extra amount on top of the basic
wage is called the overtime premium.
Advantages/disadvantages
They are easy to understand.
They do not lead to very complex negotiations when they are being revised.
They are most appropriate when the quality of output is more important than
the quantity, or where there is no basis for payment by performance.
There is no incentive for employees who are paid on a day-rate basis to
improve their performance.
Piecework system
An alternative to hourly pay is a piecework system where
employees are paid according to the number of good units
of production.
Differential piecework-is a system where the amount paid
per unit increases as the individual's production increases
Wages = Units produced*Rate of pay per unit
For example, $2.00 per unit completed. Usually paid weekly.
Company may also have in place a bonus scheme to increase
productivity e.g. a higher piecework rate for higher
productivity.
Differential piecework scheme
Differential piecework schemes offer an incentive to employees to increase
their output by paying higher rates for increased levels of production. For
example:
Up to 80 units per week, rate of pay per unit = $1.00
80 to 90 units per week, rate of pay per unit = $1.20
Above 90 units per week, rate of pay per unit = $1.30
Employers should obviously be careful to make it clear whether they intend to
pay the increased rate on all units produced, or on the extra output only.
Summary of piecework schemes
They enjoy fluctuating popularity.
They are occasionally used by employers as a means of
increasing pay levels.
They are often seen to drive employees to work too hard
to earn a satisfactory wage.
Unit labour costs
The labour cost is often a large element of the cost of a
product and the remuneration method and productivity of
the workforce can significantly affect the unit cost of the
product. The labour cost can often be a significant element
of unit cost and it can change if different remuneration
methods are introduced or if there is a change in
productivity.
Gross pay and deductions
The employer must deduct income tax and employee's benefit
contributions from the gross pay before paying the net pay to the
employees. The total labour cost for an employer is the gross pay plus
the employer's benefit contributions.
Whatever method of remuneration a business chooses the amount due to
the employees is known as the gross pay. However this is not the amount
that the employee will receive as the employer has a statutory duty to
deduct income tax. The resulting figure after these deductions is the net
pay that the employee will receive.
Accounting for labour costs
Direct labour costs are the costs of the hours worked by the
production workers, who are involved directly in the
business's productive activities, at the normal hourly rate.
Hours spent directly on making a product are charged
directly to that product. This amount would be included in
any cost card for that job.
Indirect labour costs normally include the overtime premium for direct
workers and any idle time hours for direct workers as well as the
indirect workers employment costs.
Hours spent on activities not directly making a product – for example
supervisors, administration and so on cannot be charged directly to the
product. The labour cost here is treated as an overhead. Production
labour (for instance workshop supervisor) would be a production
overhead, but the salesman, for example would be a non-production
overhead.
Overtime Premium
The basic distinction for classification of labour costs is that the labour
costs of production workers are direct costs and the labour costs of other
workers are indirect costs. However there are two specific areas where
the costs of the production workers are often treated as indirect rather
than direct.
The overtime premium is the extra amount paid over and above the
usual hourly rate. In most circumstances this is an indirect cost, even if
the normal rate is charged as a direct cost.
When overtime is worked by employees they tend to be paid an
additional premium over the general hourly rate, known as the overtime
premium or premium piece rate.
The overtime premium is generally treated as an indirect
cost rather than a direct cost of production. This is
because the overtime is an effect not of the production
itself but of its organisation and timing, and is therefore
more like an indirect overhead than a direct cost of
production. However, there is an exception to this: if a
customer requests that overtime is worked in order to
complete a job earlier, then the entire overtime payment
will normally be treated as a direct cost of that job.
Idle time
At some point during the working day it is entirely possible
that production workers find that there is no work for them
to do. This could be due to factors such as production
scheduling problems or machine breakdowns. These hours
which are paid for but during which no work is being done
are known as idle time. The cost of idle time hours tends to
be treated as an indirect labour cost.
Illustration
Bonus scheme
An individual bonus scheme only works where the employee has full
control over his own productivity or speed of his work which means
that the speed of his work is not dependent upon either the
production of other employees or the speed of machinery. Bonus
schemes can be set up in many ways but typically under an individual
scheme a standard will be set for productivity such as production of
20 units per hour.
If the employee exceeds this standard then the value of the time
saved or extra production is split between the employer and employee
according to some formula so that the employee benefits from a
bonus.
Characteristics of bonus schemes
Employees are paid more for their efficiency.
The profits arising from productivity improvements are shared between
employer and employee.
Morale of employees is likely to improve since they are seen to receive extra
reward for extra effort.
Conditions for bonus scheme
Its objectives should be clearly stated and attainable by the employees.
The rules and conditions of the scheme should be easy to understand.
It must win the full acceptance of everyone concerned.
It should be seen to be fair to employees and employers.
The bonus should ideally be paid soon after the extra effort has been made
by the employees.
Allowances should be made for external factors outside the employees'
control which reduce their productivity (machine breakdowns, material
shortages).
Only those employees who make the extra effort should be rewarded.
The scheme must be properly communicated to employees.
Individual bonus schemes
An individual bonus scheme is a remuneration scheme whereby
individual employees qualify for a bonus on top of their basic wage,
with each person's bonus being calculated separately.
The bonus is unique to the individual. It is not a share of a group
bonus.
The individual can earn a bonus by working at an above-target
standard of efficiency.
The individual earns a bigger bonus the greater their efficiency,
although the bonus scheme might incorporate quality safeguards to
prevent individuals from sacrificing quality standards for the sake of
speed and more pay.
To be successful, however, an individual bonus scheme must take
account of the following factors.
Each individual should be rewarded for the work done by that
individual. This means that each person's output and time must be
measured separately. Each person must therefore work without the
assistance of anyone else.
Work should be fairly routine, so that standard times can be set for
jobs.
The bonus should be paid soon after the work is done, to provide the
individual with the incentive to try harder.
Group bonus schemes
A group bonus scheme is an incentive plan which is related to the output
performance of an entire group of workers, a department, or even the whole
factory.
Where individual effort cannot be measured, and employees work as a team,
an individual incentive scheme is impracticable but a group bonus scheme
would be feasible.
advantages of group bonus schemes
They are easier to administer because they reduce the clerical effort
required to measure output and calculate individual bonuses.
They increase co-operation between fellow workers.
They have been found to reduce accidents, spoilage, waste and
absenteeism.
Disadvantages
The employee groups demand low efficiency standards as
a condition of accepting the scheme.
Individual employees are browbeaten by their fellow
workers for working too slowly.
Measuring labour activity
Production and productivity are common methods of measuring labour
activity. Production is the quantity or volume of output produced.
Productivity is a measure of the efficiency with which output has
been produced. An increase in production without an increase in
productivity will not reduce unit costs.
Standard hour of production is a concept used in standard costing,
and means the number of units that can be produced by one worker
working in the standard way at the standard rate for one hour.
Planning and controlling production and
productivity
Production levels can be raised as follows.
Working overtime
Hiring extra staff
Subcontracting some work to an outside firm
Managing the workforce so as to achieve more output
Production levels can be reduced as follows.
Cancelling overtime
Laying off staff
Productivity, if improved, will enable a company to achieve its production
targets in fewer hours of work, and therefore at a lower cost.
Automation
Labour cost control is largely concerned with
productivity. Rising wage rates have increased
automation, which in turn has improved productivity and
reduced costs.
Where automation is introduced, productivity is often,
but misleadingly, measured in terms of output per man
hour.
Efficiency, capacity and production
volume ratios
Illustration
Labour turnover
Labour turnover is the rate at which employees leave a company and this
rate should be kept as low as possible. The cost of labour turnover can be
divided into preventative and replacement costs.
The reasons for labour turnover
Unavoidable Reasons:
Illness or accidents
A family move away from the locality
Marriage, pregnancy or difficulties with child care provision
Retirement or death
Avoidable reasons (to some extent)
Paying a lower wage rate than is available elsewhere
Requiring employees to work in unsafe or highly stressful conditions
Requiring employees to work uncongenial hours
Poor relationships between management and staff
Lack of opportunity for career enhancement
Requiring employees to work in inaccessible places (eg no public transport)
Discharging employees for misconduct, bad timekeeping or unsuitability
Measuring labour turnover
Labour turnover is a measure of the number of employees leaving/being
recruited in a period of time expressed as a percentage of the total labour
force.
The costs of labour turnover
The costs of labour turnover can be large and management
should attempt to keep labour turnover as low as possible so
as to minimise these costs. The cost of labour turnover may
be divided into the following.
Preventative costs
Replacement costs
Preventative costs
These are costs incurred in order to prevent employees leaving; they include the
following.
Cost of personnel administration incurred in maintaining good relationships
Cost of medical services including check-ups, nursing staff and so on
Cost of welfare services, including sports facilities and canteen meals
Pension schemes providing security for employees
Replacement costs
These are the costs incurred as a result of hiring new employees; they include
the following.
Cost of selection and placement
Inefficiency of new labour; productivity will be lower
Costs of training
Loss of output due to delay in new labour becoming available
Increased wastage and spoilage due to lack of expertise among new staff
The possibility of more frequent accidents at work
Cost of tool and machine breakages
The prevention of high labour turnover
Labour turnover will be reduced by the following actions.
Paying satisfactory wages
Offering satisfactory hours and conditions of work
Creating a good informal relationship between members of the workforce
Offering good training schemes and a well-understood career or promotion
ladder
Improving the content of jobs to create job satisfaction
Proper planning so as to avoid redundancies
Investigating the cause of an apparently high labour turnover
Procedure of calculating wage cost
1) Calculate basic hours for workers (how many hours they should work).
2) Compare this with the total hours worked to find overtime hours.
3) Calculate workers gross wages.
4) Calculate deductions and net wages.
5) Calculate value of direct labour.
6) Calculate value of indirect labour including indirect workers and overtime
premiums and idle time for direct workers.
7) Check that the total of direct and indirect labour equals gross wages.
Illustration
Ledger accounting for labour costs
The gross pay is debited to the wages control account and
the direct cost element is then transferred to the work in
progress account whilst the indirect cost element is
transferred to the production overhead control account.
Steps
1. Debit the wages control account with the gross pay which is made up of the
net amount paid to the employees and the income tax and benefit
contributions.
2. The other sides of the entries are to the bank account for the net pay and to
a tax authorities creditor account for the income tax and benefit
contributions as these amounts must be paid over to t he tax authorities
shortly.
3. The direct labour cost is then credited to the wages control account and
debited to the work in progress account, as were direct materials, as part of
the direct cost of making the products.
[Link] indirect labour cost is credited to the wages control
account and debited to the production overhead control
account together with any indirect materials used.
Note!
As we have seen the labour cost is the gross wages or
salaries of the employees. It is important that we distinguish
between direct labour and indirect labour and this will be
done by careful coding of the payroll.
The payroll will consist of a listing for each department of
the net pay, deductions and overtime details.
These must be coded correctly to ensure that the gross pay
is correctly analysed between direct and indirect labour and
is collected by the correct cost centre.
Summary
