LABOUR COSTS / ACCOUNTING FOR LABOUR.

Introduction. Core principle i.e. Direct labour, Direct expenses. Further recall labour cost which is classified as direct and indirect. They form the labour cost which form a significant percentage of the total cost of production in a manufacturing organization and there is need to exercise maximum care to minimize these costs. Minimizing cost down not mean reducing cost but means getting the optimal efficient and productivity of the employee. Purposes of labour Cost. a) Calculate correct gross and net pair for each employee. b) For financial accounting purposes. c) For management accounting purposes i.e. stock valuation. Decision making and control purposes Elements of Labour Cost. Labour Cost can either be direct, or Indirect they include. a) Basic Wages. b) Overtime premium c) Bonus payment d) Idle time e) Labour turnover. Remuneration methods. Various methods by which basic wages can be determined they include. i) ii) iii) iv) Fixed salary per month. Time based systems. Piece works systems. Bonus / incentive schemes.

Fixed Salary per month. Mainly applys to permanent workers who received a fixed salary every month. Time based systems. Wages determined by number of worked. If an employee works more than their basis hours then an overtime payment might be made.

Strathmore University

2009

Formula.

Total Wages = Hours x Basic rate of + Overtime hour worked + Overtime premium worked pay per hour per hour
Illustration James is a direct labour employee who works a stand 40 hours per week. He paid basic rate $ 15 per hour. Overtime paid at a time and half in a certain week James works for 50 hours and due to his improved efficiency he is entitled to a bonus of $ 100 Required. a) Basic pay for standard hours. = 40 x 15 = $ 600 b) Basic pay for overtime hours. = 10 x 15 = $ 15 c) Overtime Premium =10 x 15/2 = $75 d) Classify amount paid to James as Direct / Indirect labour cost. Direct Basic Standard Basic Overtime Indirect Bonus Overtime Premium.

PIECEWORK SYSTEMS. In this case wages depend on level output achieved and is expressed as follows. Basic earnings = Unit Produced x Rate of Pay per unit.

Piece rate Remuneration.

i) Straight Piece Work.

Strathmore University

2009

The basic rate per unit remains constant irrespective number of units produced ii) Straight Piecework with guaranteed minimum wage.

Employees paid on number of units produced bill one is guaranteed of a minimum wage since there are occasions when production doesnt take place due to unavoidable circumstances e.g. power failure shortage of material machine breakdown e.t.c. Illustration. Janie is paid $ 10 for each unit produced she is guaranteed a minimum wage of $ 1500 for 40 hour week in a series of 4 weeks she produces 130, 150, 170 and 180 units. Production overheads are added at rate of $ 5 per direct labour hour. Required. Calculate. a) Ge Jane pay per week. b) Production overhead per week c) Conversation Cost. d) Unit Conversion Cost. a) Week 1 150 units Pay 130 x 10 =$1300 p 1500 = $ 1500 Week 2 150 units Pay 150 x 10 $1500 = 1500 = $ 1500 Week 3 170 units Pay 170 x 10 =$1700 f 1500 = $ 1700 Week 4 180 units. Pay 180 x 10 =$1800 f 1500 = $1800 b) Production Overhead. $ 5 for every hour.

Strathmore University

2009

40 hours. 40 x 5 = $ 200 per week c) Conversion Cost. Direct labour week Week 1 Week 2 Week 3 Week 4 Total 1500 1500 1700 1800 6500 $6500

$6500 + $800 Conversion Cost $ 7300 d) Unit Conversion Cost Total Units. Week 1 Week 2 Week 3 Week 4 Total 130 150 170 180 630

Total 630 Units. 7300 = Wrong 630 = $11.59

iii)

Differential Piecework.

Employees basic rate pay per unit changes as level of activity changes rate per unit increases on additional units produced. When certain output levels are reached is doesnt provide security for a guaranteed wage but it can enhance incentive for increased rates for higher production. Illustration. X Ltd Operates a differential piecework system and the following weekly rates have been set. Weekly Production. 1 999 Units 1000 1999 Units 2000 Above units Rate of pay pr unit. 2 3 5

Strathmore University

2009

Required. How much would be paid to following employees for week. Peter Mercy 1500 Units 2400 Units 1998 1503 = $ 3501 1998 + 3000 + $3005 = $7003

Advantages of time rate over piece rate. i) ii) iii) iv) Quality of output is better since there is no hurry to produce more unit. Employees feel secure and they are assured of some pay at the end of the period if time is determining factor. Does not lead to hard negotiations when rates are being revised. More appropriate when quality of output is more important than quality.

Disadvantages time rate over piecework. i) ii) No incentive for employees paid on a daily rate to improve performance as more efficient are equally compensated as less efficient. Quality of output is much lower and supervisory cost are high since employees need close attention.

Bonus / Incentive Schemes. Bonus paid to employees to increase efficiency and productive productivity is a measure of efficiency with which output have been produced. An increase in production without an increase in productivity will not reduce unit cost. Productivity is improved will enable a company to achieve its production targets in few hours of work and therefore at a lower cost. Illustration. Suppose than an employee is expected to produce 4 units every hour he works if during a 40 hour week the employee makes 175 units in 35 hours. Required. Compute efficiency or productivity of employee using a) Unit produced b) Hours worked.

Strathmore University

2009

a )1Hour 4Units. 25 Hour 175Units. 175 = 1Hour 5Units. 35 5 100 = 125% 4

b) 4 55 = 140units in 45hr week . = 175 100 140

4Units

1 Hour

175 units in 35hour week 5Units 1 hour = 125%

1 100% = 25% more efficient than exp ected . 4 175 units 35hours. Expected 175 units 43.75 hours 42.75 100 35 = 125%
N.B. A producing ratio greater than 100% indicates actual efficiency is better than the expected standard level of efficiency. Characteristics of bonus / incentive schemes. i) ii) iii) Employees paid more for efficiency. Insipite of extra labour cost unit of output is reduced and profit earned per unit of sales is increased. Moral of employees increase. Due to the receipt of extra reward for extra effort.

Strathmore University

2009

Conditions of a successful bonus scheme. i) ii) iii) iv) v) vi) Objective should be clearly stated and attainable by employees. Rules and conditions of the scheme should be easy to understand and not liable to misinterpretations. Must be fully acceptable by everyone concerned including trade union negotiator and official. Allowance should be made for external factors outside employees control which reduce productivity such as machine breakdown or raw materials shortage. Only those employees who made the extra effort should be rewarded. The scheme must be properly communicated to the employee.

Types of Incentive Schemes.

i) ii) iii) iv) v) vi) High day rate system. Individual bonus scheme. Group bonus scheme. Profit sharing schemes. Employ share ownership plan. Value added incentive schemes.

i)

High Day Rate System.

A system where employees are paid a high hourly wage in expectation that they will work more efficiently than similar employees on a lower rate in a different company. Advantages. a) Simple to calculate and easy to understand. b) Guarantees employees a consistently high wage. Disadvantages. a) Employees cannot earn more than fixed hourly rate for their extra effort. b) Employees may prefer to work at normal rate of output.

ii)

Individual Bonus Scheme.

A remuneration scheme where individual employees qualify for a bonus on top of basic wage with each persons being calculated separately.

Strathmore University

2009

Illustration. X Ltd operates a premium bonus scheme for employees of 75% of time saved compared with standard time allowance for a job at the normal hourly rate. The data relating to a certain job completed by an employee is as follows. Allowed time for a job Time taken to complete Normal hourly rate of pay Required. Total pay of employee for job. 4 Hours. 3 hours. 8

3 Hours 8 = $24 8 75 60 1 = = $6 100 100 = $6 + 24 = $30

iii)

Group Bonus Scheme.

Many a times when individual effort cannot be measured and sometime the employees need to enhance the collaboration between the employees so that they work towards their organization goals as a team. In such cases group bonus schemes are administered which are incentive plan which is related to the output performance of an entire group of workers a department or even the core factory. Advantages. a) Easy to administer because they reduce clerical effort required to measure output and calculate individual bonuses. b) Employees are motivated to work as a team thereby increasing their cooperation among each other. c) Creates healthy working atmosphere reducing accidents spoilage waste e.t.c. Disadvantages. a) Increases in fighting among employees especially those jobs with many processes. b) Demotivates some of employees especially those who see fellow workers as lazy.

Strathmore University

2009

c) The employees group demands allow efficiency standards as a condition of accepting the scheme.

iv)

Profit Sharing Scheme.

In this scheme employees participate in sharing profit of company. If the profit for a given period surpass a pre determined limit. this scheme make employees feel part of company via profit sharing and are motivated to work hard to enjoy fruits of hard work. Advantages. a) Employees feel part of company reducing disturbances like strikes and always work hard to surpass profit limit. b) Company will only pay what it can afford out or actual profit. c) This type of bonus is also paid to non production personnel Disadvantages. a) Profit limit may be too high discouraging employees to wok hard i.e. may be two optimistic and unrealistic. b) Company can have many employees and may be what each employee get can be too little to impact motivation on them. c) There may be other factors outside control of employees which hinder effort to surplus profit limit.

v)

Employee Share Ownership Plan.

These are share options given to employees who work for a certain period of time. The predetermined future period at a predetermined price. Method reduce labour turnover since most employees remain to become shareholders of company Advantages. a) Employees are motivated to work hard for company since they become stake holders / shareholders. b) Through shareownership employees can earn extra income in form of dividends.

Disadvantages. a) Benefits are not certain as market value of shares at a future date cannot realistically be predicated in advance. Exercise price of options may be higher than market price of shares.

Strathmore University

2009

b) Benefits are not immediate as scheme must be existent for a number of years before members can exercise their right.

vi)

Value Added Incentive Schemes.

Alternative to profit sharing as a business performance measure and can be used as basis of incentive scheme. Formula is as follows. Value Added = Sales (Cost of Materials + Services).

Recording labour Cost.

Labour attendance time is recorded on for example an attendance record or clock card. Job time may be recorded on daily time sheet or weekly time sheet or job cards, depending on circumstance. Labour cost of piece workers is recorded or a piecework ticket or on an operation card

Idle Time / Unproductive Time.

This unproductive time paid for i.e. workers are paid but no goods have been produced e.g. when there is power failure, machine breakdown, training e.t.c. Idle time has a cost because employees will still be paid basic salary / wage for these unproductive hours therefore should be a record of idle time. Idle time can either be avoidable or unavoidable. Avoidable idle time. Due to production disruption due to shortage of raw materials, insufficient job schedules. e.t.c. N.B. Cost of paying for hours of avoidable idle time that simply ought not to have been incurred and should be written off in income statement.

Unavoidable idle time. Uncontrollable cost of the business e.g. unexpected fall in demand for a product, sickness of employees, strikes by suppliers e.t.c. affecting production.

Strathmore University

10

2009

N.B. Unavoidable idle time of direct workers may be included in the cost of product as production overhead all other idle time is treated as period cost.

Idletime Ratio =

Idletime 100 Total attendanceTime

LABOUR TURNOVER.
A measure of the proportion of people leaving relative to the average number of people employed over a period of time. This rate should be kept as low as possible. Management might wish to monitor labour turnover so that control measures might be considered if turnover rate is too high since business is losing experience and valuable staff at a fast rate. Labour turnover is calculated for any given period by using this formula.

labour turnover rate =

Re placement 100 Average number of employees in the period

The labour turnover percentage calculated can be compared with past figures, targets and industry averages. It provides an indication of whether an unacceptably high number of people are leaving the organization.

Illustration. 1) At 1st January a company employed 42200 employees at 31st Dec employee number 45600 during the year 2400 chose to leave the company. Required. Labour turnover rate for the year.

LT =

2400 100 = 5.47% (45000 + 42200) / 2

Strathmore University

11

2009

2) A company ahs 42000 staff at begin during year there was a major restructuring and 15000 staff company to work for another company 3000 new employees joined Co. in the year.

Required. Calculate labour turnover rate for 2006 42000 15000 = 27000

42000 + 27000 2 3000 100 = 8.7% 34500

Causes of Labour Turnover. Can be divided into two - Avoidable - Unavoidable. Avoidable. i) ii) iii) iv) v) Poor remuneration. Lack of training opportunities Lack of promotion prospects. Poor working conditions. Bullying in work place (Harassment).

Unavoidable. i) ii) iii) iv) v) Illness, death. Retirement Relocation, redeployment Family matters. Natural Calamities.

Cost of labour turnover.

Strathmore University 12 2009

Every time an employee leaves an organization will incur costs that are associated with replacing employee. These costs are known as replacement costs. i) ii) iii) iv) v) vi) Advertising cost. Cost of selection. Training new employees. Reduced efficiency until new employee reaches required skill. Loss of output due to delay of new labour becoming available. Wastage before employee comes up to par.

A high labour turnover rate tends to lower performance of employee who remain in the organization such employees may worry of extra burden of training new members and temporary new duties imposed upon them. In order to keep labour turnover rate to a minimum organization should aim to prevent employees from leaving such preventive measures come with there own cost as preventive cost which include. i) ii) iii) iv) Pay competitive wages and salaries it remuneration is poor. Improve poor working condition. Offer good training opportunities. Promotion prospect within organization.

Accounting For Labour Costs.

Labour costs are an expense and are recorded in the organization income statement. Accounting transactions related to labour are recorded in labour account. The labour account is Dr with labour cost income by organization. Total labour costs are then analyzed into direct and indirect labour cost. Accounting entries for labour cost. i) When labour cost are incurred / paid. DR. labour / wages control account AC CR Bank A/C. ii) XX

When direct labour cost on incomplete work are incurred. DR. Work in progress AC XX CR: Labour / Wages Control A/C XX When indirect labour cost are incurred DR: Production overhead A/C XX

iii)

Strathmore University

13

2009

CR: Labour / Wages control account A/C

XX.

FORMAT FOR LABOUR WAGES CONTROL ACCOUNT. Dr Labour / Wages Control Account. $ Bank Deductions XX XX WIP (Direct labour) Production Overheads Indirect labour (A) Overtime premium (B) Shift premium Sick Pay (D) Idle time (E) XX XX XX XX XX XX XX CR $ XX

DR WIP A/C. $ Wages and Labour control A/c XX Balance c/d

CR. $

XX Balance b/f XX

XX

Dr

Production Overheads A/C Direct workers

Cr Indirect workers Total

Strathmore University

14

2009

Basic pay for basic hours Overtime basic pay Premium Training costs Sick pay Idle time

107500 25000 12000 6250 1875 3000

42500 11250 5625 3125 625

150000 36250 18125 9375 2500 3000

N.B. Assume all amount was paid by and of period. Required. Using information given prepare the labour / wage control A/C. Dr Labour / Wages Control $ Bank 210250 WIP (Direct labour) Production Overheads Indirect labour Overhead premium Training cost Sick pay Idle time 279250 53750 18125 9375 2500 3000 219250 $ 132500 Cr

Illustration II. Direct workers Indirect workers Total

Strathmore University

15

2009

Basic pay for basic hours Overtime basic pay Premium Training costs Sick pay Idle time

79200 27400 14600 8500 1000 10000

48400 14800 7400 2400 800

1276000 42200 22000 5700 1800 10000

Amount paid to direct workers was 105300 and amount paid to indirect was 58200 Repair labour and wage account Dr Labour / Wages Control $ Bank Deductions 163500 46000 WIP (Direct labour) Overheads Indirect labour Overhead premium Training cost Sick pay Idle time 209500 63200 22000 5900 1800 10000 209500 $ 106600 Cr

Illustration III. X Ltd has recorded the following cost for direct workers for month of Dec. $ 400000 30000 10000

Basic Pay Overtime premium Holiday pay

Strathmore University

16

2009

Idle time Sick pay Gross wages incurred

5000 5000 480000

Required. Accounting entries for this wages cost. Basic pay DRL WIP / a/c $400000 (Direct labour ) CR Wages control a/c $ 400000 Production overheads. DR Production overhead a/c $ 50000 CR Wage control a/c $ 50000 Gross wages incurred. DR. Wages control a/c $ 450000 CR: Bank a/c $ 450000

Strathmore University

17

2009