ACCOUNTING FOR LABOUR COSTS

Introduction

This chapter looks at how remuneration is calculated and accounted for.

REMUNERATION METHODS

1. Labour costs can arise from:

• Basic wage or salary

• Overtime premiums

• Bonuses

• Holiday pay

• Sick Pay

• Payroll taxes

Many countries pay wages and salaries under a ‘pay as you earn scheme’ which meansthat the

employer deducts the employees’ income tax from the gross wage and pays that over directly to

the tax authority. Only the net amount after tax is then paid to the employee.

Employee remuneration can be based on the following approaches:

(1) A constant weekly or monthly amount

This is easy to calculate:

Labour cost = remuneration per period x number of periods

(2) An amount based on hours worked (basic plus overtime)

Illustration

An employee works for 52 hours are worked in a week. Basic week is 40 hours, thebasic rate of

pay = $10, and overtime is paid at time and one half.

Basic pay: hours worked @ basic rate 52 x $10 520

Overtime premium: (52 – 40) x $10 x 50% 60

Total pay US$580

(3) An amount based on units produced: piecework

Often there is a guaranteed minimum amount of pay so as to comply with minimumwage

rate legislation.

Illustration 1

Minimum pay/week = $250

Piece rate = $3/unit

If 100 units are made in a week then the pay will be $3 x 100 = $300

If 80 units are made in a week then the pay will by $250 (because the piece rate amount would be

only $240.

Illustration 2

A business has a piecework system for remuneration of its employees. The system works as

follows:

$3.20 per unit for up to 40 units per week

$3.50 per unit for each unit between 41 and 50 units per week

$3.80 per unit for each unit over 51 units per week There is

a guaranteed weekly wage of $120 per week.

One employee has produced the following amounts for the last two weeks:

Week 1 35 units

Week 2 44 units

What is the employee's gross wage for week 1 and week 2?

Solution

Week 1 Week

2
$

35 units × $3.20 112

40 units × $3.20 128

4 units × $3.50 14

112 142

In week 1 as the piecework rate is less than the guaranteed weekly minimum theamount to

be paid will

be the guaranteed amount of $120. In week 2 the employee's earnings are $142.
Practice Question

Solution
(4) Bonus/ Incentive schemes

There are many different types of bonus scheme and any question would have toset out the

precise rules.

Illustration 1

Basic pay = $9/hour for a 40 hour week.

Normal production in that time = 120 units

Bonus = 50% of the time saved on production paid at time and a third

What will be the total wage in a week in which 150 units are made in 40 hours?

Answer

Basic pay = 40 x $9 360

150 units should take 50 hours

150 units did take 40 hours

Hours saved 10 hours

Bonus = 50% x 10 x 9 x 1 ⅓ 60

Total pay 420

5. 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.

(a) The bonus is unique to the individual. It is not a share of a group bonus.

(b) The individual can earn a bonus by working at an above-target standard of efficiency.

(c) 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.

(a) 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.

(b) Work should be fairly routine, so that standard times can be set for jobs.

(c) The bonus should be paid soon after the work is done, to provide the individual with the

incentive to try harder.

Example: Premium bonus scheme

The following data relate to work at a certain factory.

Normal working day 8 hours

Basic rate of pay per hour $6

Standard time allowed to produce 1 unit 2 minutes

Premium bonus 75% of time saved at basic rate

What will be the labour cost in a day when 340 units are made?
A $48

B $51

C $63

D $68

Solution

The correct answer is C.

Minutes

Standard time for 340 units ( 2 minutes) 680

Actual time (8 hours per day) 480

Time saved 200

Bonus = 75% * 200 minutes * $6 per hour 15

Basic pay = 8 hours * $6 48

Total labour cost 63

6. High day-rate system

A high day-rate system is a system where employees are paid a high hourly wage rate in the

expectation that they will work more efficiently than similar employees on a lower hourly rate in a

different company.

Example: High day-rate system

For example if an employee would make 100 units in a 40 hour week if they were paid $2 per hour,

but 120 units if they were paid $2.50 per hour, and if production overhead is added to cost at the rate

of $2 per direct labour hour, costs per unit of output would be as follows.

Solution

7. 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.

The other advantages of group bonus schemes are as follows.

(a) They are easier to administer because they reduce the clerical effort required to measure output
and calculate individual bonuses.

(b) They increase co-operation between fellow workers.

(c) They have been found to reduce accidents, spoilage, waste and absenteeism.

Serious disadvantages would occur in the following circumstances.

(a) The employee groups demand low efficiency standards as a condition of accepting the scheme.

(b) Individual employees are browbeaten by their fellow workers for working too slowly.

Practice Question

Solution
 LESSON 14

GROSS AND NET EARNINGS

• Gross pay:

This refers to the total amount earned by the employee

• Net pay:

This is the amount paid to the employee after the employer makes deduction for incometax and

certain statutory amounts. The employer must deduct income tax and employee's benefit

contributions from the gross pay before paying the net pay to the employees.

• Total labour cost to employer:

This comprises of the employees’ gross pay plus any additional payrolltaxes

(and perhaps pension costs) that the employer has to bear.

Example: gross pay to net pay

An employee is paid at an hourly rate of $7.00 for a 35 hour week with any overtime hourspaid at

time and a half. During week 22 the employee worked for 41 hours. The income tax to be deducted

was $55, the Employee's benefit contributions for the week were $28,and the Employer's benefit

contributions were $29.

What is the employee's net pay?

Solution

Gross pay – 41 hours $7.00 287

6 hours $3.50 21
LESSON 14

Total gross pay 308

Less: Income tax (55)

Employee's benefit contributions (28)

Net pay 225

 LESSON 14

Employer costs

As far as the employer is concerned the cost of employment is the gross pay of the employee.

Although the employee is only paid the net amount, the employer must pay the deductions from

gross pay (for income tax and the employee's benefit contributions)over to the relevant authorities.

There is also a further cost to the employer as he must also pay Employer's benefit contributions

on behalf of each employee, together with anyadditional employer's pension contributions that

may be made into the pension scheme for the employee.

Example: labour cost

Returning to the employee from the previous example the Employer's benefit contributionfor the

week is $31. What is the labour cost to the employer for this employee for the week?

Solution

Gross pay 308

Employer's benefit contribution 31

Total labour cost 339

In some businesses there may be an additional cost to the employer for example, if the employer's

agreement is that he will contribute to the pension scheme on the employee'sbehalf.

LESSON 14

ACCOUNTING FOR LABOUR COSTS

Direct labour costs are the costs of the hours worked by the production workers, whoare involved

directly in the business's productive activities, at the normal hourly rate.

Indirect labour costs normally include the overtime premium for direct workers and anyidle time

hours for direct workers as well as the indirect workers employment costs.

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 duringwhich no work is being done are

known as idle time. The cost of idle time hours tends tobe treated as an indirect labour cost.

Idle time occurs when employees cannot get on with their work, through no fault of their own.

Examples are as follows.

Machine breakdowns

Shortage of work

Example: overtime and idle time

Given below are the labour costs incurred by a manufacturing business for the weekcommencing

23 July 20X5.

Direct production workers 1,200 hours at $6.40 per hour

Direct production workers overtime hours 200 at $9.40 per hour

LESSON 14

Indirect workers 400 hours at $5.20 per hr

Indirect workers overtime hours 50 at $8.00 per hour

Of the hours paid to the direct production workers 40 of these were idle time hours

Solution
LESSON 14

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 theproduction

overhead

control account.

A business paid its employees net pay of $15,000 for week 34. This was after deductionsfor income

tax and benefit contributions of $6,000. The direct labour element of this was $18,000and the

indirect labour cost was $3,000. Write up the ledger accounts to reflect the labour cost

Solution
LESSON 14

The first step is to 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. 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 the tax authorities

shortly.

Note:

The labour costs are classified as direct or indirect depending on what caused those costs:

Direct labour costs: all hours worked x normal hourly rate

Indirect labour costs: overtime premium, idle time, sick pay, holiday pay.
Practice Question

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 preventativeand replacement

costs.

4.1 The reasons for labour turnover

There are many reasons why employees will leave their job. It may be because they wishto go to

work for another company or organisation. Alternatively it may be for one of the following

unavoidable reasons.

Illness or accidents
 A family move away from the locality

Marriage, pregnancy or difficulties with child care provision

Retirement or death

In addition to the above examples, other causes of labour turnover are as follows.

Paying a lower wage rate than is available elsewhere

Requiring employees to work in unsafe or highly stressful conditionsRequiring

employees to work unsociable hours

Poor relationships between management and staff Lack of

opportunity for career enhancement Requiring employees

to work in inaccessible places

Discharging employees for misconduct, bad timekeeping or unsuitability

4.2 Measuring labour turnover

Labour turnover is a measure of the number of employees leaving/being recruited ina period

of time (say one year) expressed as a percentage of the total labour force.

Illustration 1

(a) Florence Co had a staff numbering 800 at the beginning of 20X1 and 1,200 at the endof that

year. Four hundred employees resigned on 30 June, and were immediately

 replaced by 400 new employees on 1 July. 400 extra employees were also recruited at that time.

What is the labour turnover rate?

Illustration 2

Rome Co had a staff of 2,000 at the beginning of 20X1 and, owing to a series of redundancies

caused by the recession, 1,000 at the end of the year. Voluntary redundancy was taken by 1,500

staff at the end of June, 500 more than the company had anticipated, and theseexcess redundancies

were immediately replaced by new joiners.

The labour turnover rate is calculated as follows.

Practice Question

Solution
4.3 The costs of labour turnover

The costs of labour turnover can be large and management should attempt to keep labourturnover 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

4.3.1 Replacement costs

These are the costs incurred as a result of hiring new employees and they include thefollowing.

(a) Cost of selection and placement.

(b) Inefficiency of new labour; productivity will be lower.

(c) Costs of training; training costs will include formal training courses plus the costs ofon-the-

job nstructors diverted from their own work to teach new recruits.

(d) Loss of output due to delay in new labour becoming available.

(e) Increased wastage and spoilage due to lack of expertise among new staff.

(f) The possibility of more frequent accidents at work.

(g) Cost of tool and machine breakages.

4.3.2 Preventative costs

These are costs incurred in order to prevent employees leaving and they include thefollowing.

(a) Cost of personnel administration incurred in maintaining good relationships.

(b) Cost of medical services including check-ups, nursing staff and so on.

(c) Cost of welfare services, including sports facilities, laundry services and canteenmeals.

(d) Pension schemes providing security to employees.

(e) Cost of providing training and offering career progression.

4.4 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 good relations between fellow workers, supervisors and subordinates Offering

good training schemes and a well-understood career or promotion ladderImproving the

content of jobs to create job satisfaction

Proper planning so as to avoid redundancies Investigating

the cause of high labour turnover rates

Measuring labour efficiency and utilization

Labour costs are often a large proportion of the total costs incurred by many organisations. It is

important therefore that the performance of the labour force iscontinually measured.
Labour performance is generally measured by comparing actual results for an organisation with

budgets.

5.1.1 Efficiency, capacity utilisation and production volume ratios

The ways of measuring labour performance are:Efficiency

ratio

Capacity utilisation ratio

 Production volume ratio

These ratios are based on direct labour hours and are usually expressed as percentages.Efficiency

ratio* Capacity utilisation ratio = Production volume ratio

Illustration

Barney Rubble Co budgets to make 25,000 units of output (in four direct labour hourseach)

during a

budget period of 100,000 direct labour hours.

Actual output during the period was 27,000 units which took 120,000 direct labour hoursto make.

Required

Calculate the efficiency, capacity utilisation and production volume ratios.solution

These ratios may be used, therefore, to measure the performance of the labour force.
5.1.3 Idle time
We considered idle time earlier. A useful ratio for the control of idle time is the idle time ratio.

This ratio is useful because it shows the proportion of available hours which were lost as a result

of idle

time.