Accounting for Labour Costs PDF

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CHAPTER FOUR ACCOUNTING FOR LABOUR COSTS 4.1.0 Introduction Every employee of a business from the most senior manager to the most junior member of the team is entitled to a contract of employment which explains among other things the basis on which he will be remunerated. There are four such bases in popular use: (a) (b) (c) (d)

A fixed salary for calendar period (week, month, or year); A fixed amount per unit of attendance time – normally per hour; A fixed amount per unit of output achieved (piecework); A combination of a day rate and a bonus related to the output achieved.

4.2.0 Control of Costs and Efficiency Nearly all business costs will be influenced in some way by the efficiency of the people employed, so that the control of labour costs and performance is highly significant. The main elements in effective labour control are: (a) Production planning – This includes production engineering, process engineering planning, scheduling, method study and work measurement. (b) Use of a labour budget – This can be produced with aid of data from production planning. (c) Use of labour standards – Actual costs are compared with predetermined standards, the variances computed and remedial action taken. (d) Use of incentive schemes – Efficiency reports from departments help to ascertain the effectiveness of such schemes (but note that the desire to increase output can result in the lowering of production quality). (e) Labour performance reports – These should cover both efficiency and use of labour. 4.3.0 Timekeeping In most businesses, records are needed of the time spent by each worker in the factory (attendance time) and time spent on the operations, processes or products in the factory (job time). Such timekeeping provides basic data for statutory records, payroll preparation, ascertainment and control of labour costs of an operation or product, overhead distribution (where based on wages or labour hours) and statistical analysis of labour records for determining productivity. The various forms of job records are: (a) Daily time sheets – Each employee completes this sheet indicating time spent by each work on the job and passed on to the cost office each day. (b) Weekly time sheets – These are similar to daily time sheets except they are passed to the cost office at the end of the week.

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(c) Job cards – A job card is prepared for each job or operation, and on it is recorded the time spent on that job by the employee concerned. Job cards also carry instructions to the operator as to how the job is to be carried out. (d) Route cards – These are similar to job cards, except that they follow the product through the works and include details of all operations to be performed. They thus carry the cost of all operations on a job, which is very useful for control purposes. 4.4.0 Efficiency Where predetermined standard times are set for particular jobs, these times can be noted on the relevant job card. The efficiency with which the operator has carried out the work can then be calculated as: time allowed time taken

x 100 = efficiency %

Standard times are normally derived from work study and necessitates standard specifications and methods of production. 4.5.0 Methods of Remuneration Methods of remuneration may be divided into the following broad categories: (a) (b) (c) (d)

Time rates Piecework rates Premium bonus rates Collective bonus rates

4.5.1 Time rates Time rates (sometimes referred to as day or flat rates) are paid either when the nature of the work being done makes it difficult to identify a specific item (or piece) for which the rate could be used (eg, the duties of a night security officer), or where the work involves a high degree of skill and/or the use of expensive material (eg, tool refurbishment). In the later case, payment by results (eg, according to number of items produced) could encourage employees to rush their work, resulting in defective output and excessive use of materials. Advantages of a time rate   

The method is easily understood by both wages clerk and employees; It is the only effective method where there is difficult in measuring effort (eg, in case of indirect labour); The method can be adapted to different skills and grades by fixing a number of hourly rates to take account of those skills and/or grades, thus incentive to produce quality work rather than quantity can be provided.

Disadvantages of a time rate 

There may be no special incentive for the employee to work hard;

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The efforts of conscientious and industrious workers may not be adequately rewarded, while lazy or inefficient workers may receive more pay than their work effort merits; It is necessary to have close supervision of personnel to ensure that production goes on at a reasonable rate.

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4.5.2 Piecework rates Under the piecework rate scheme the worker’s remuneration is calculated by multiplying the quantity of good production, measured either in units or standard hours or minutes, by the fixed rate per piece. Example 1 Mwango Chibombelo works in Livingstone producing carved wooden animals for a small company supplying the tourist market. In week 26 his production was: Standard time allowed 6 Giraffes

2 hours

5 Lions

1.5 hours

12 Owls

1 hour

6 Golden Eagles

2 hours

He is paid K30 per standard hour produced and works when he wishes, at home in his croft. What are his earnings for week 26? Solution Standard Hours Produced Giraffes

6 @ 2 hours

12

Lions

5 @ 1.5 hours

7.5

Owls

12 @ 1 hours

12

Golden Eagles 6 @ 2 hours

12 43.5 hours

Therefore, earnings week 26 = 43.5 hrs x K30 = K1,305

Advantages of piecework rates  

There is a strong incentive for the employees, knowing that their earnings will vary in direct proportion to their effort; The hardworking employee is rewarded, while the lazy or incompetent employee receives lower earnings. Page 3 of 12

Disadvantages of piecework rates   

Quality of output is often sacrificed in order to achieve quantity; High supervision and inspection costs are needed in order to ensure the reasonable standards are maintained. If a fair total wage is determined by using as a base the expected output of the average experienced worker, the learner or the worker who is slow (eg, because of physical infirmity or because he is given inferior equipment and/or machine) will be penalised.

4.5.3 Premium bonus scheme A premium bonus scheme is, in effect, a compromise between the simple day work and the straight piecework systems in that it relates earnings to both the time worked and the output achieved. Under such a scheme the worker’s earnings are made up of: (a) A day rate amount, based on hours worked, and (b) A bonus (which is added to the day rate figure), based on the quantity of output achieved (or, put another way, the time saved in achieving the particular level of output) The advantages of bonus scheme are:  

They provide a high incentive; The worker’s earnings are related to his effort.

The disadvantages of such schemes are:  

They are often difficult to understand; They tend to require a large amount of clerical work to cope with the earnings calculations.

4.5.4 Collective bonus schemes Sometimes it is difficult to ascertain to what extent production efficiency is solely attributable to the performance of individuals, although it may be clear that there has been increased productivity by a group of operatives working together. Again, although not directly engaged on production, the factory staf (or, possibly, all the company’s staff) may over a period work so efficiently that there is a marked saving in company costs. Example 2 10 workers are engaged as a team on producing item A. The standard of production set is 40 units of A per day, and the terms of employment provide that the team will receive a bonus of K1,000 for every 20% increase in daily production of 40 units. For increases other than multiples of 20%, the bonus will be the corresponding proportion of K1,000. On day 37, the team produced 52 units. Assuming that the bonus is shared equally, how much bonus will each team member receive? Solution Page 4 of 12

Increase in production = There;

bonus =

30 20

52 −40 40

x 100% = 30%

x K1,000 = K1,500

Bonus per worker =

K 1,500 10

= K150

4.6.0 Treatment of Overtime and Sundry Payments 4.6.1 Overtime Overtime is usually paid at some rate over the normal (usually time and a half or double). The excess over the normal rate is over time premium, which is shown in a separate column in the payroll. Charging of the overtime will vary according to the circumstances. Some examples are given below: (a) Allocate directly to the job if the overtime is worked on the customer’s specific instructions; (b) Allocate to a separate general production overhead account if arising from general pressure of work; (c) Allocate to the department responsible for the delay which necessitated working overtime; (d) Charge to the department where work is done, if resulting from a controllable fault arising in that department; (e) Charge directly to costing profit and loss account, if due to circumstances beyond the control of any department (eg, power failure, fire, national strike, etc). 4.6.2 Work on holiday Work performed on days set aside for holidays is normally paid for at above normal rates. Work on a public holiday is often paid at double time rate. The premium included in such payment should be shown in a separate column in the payroll and treated either as a general overhead expense or as a direct charge to particular jobs if the holiday work is done at the request of the customers concerned. 4.6.3 Holiday with pay Holiday pay is non-productive, but it is nevertheless charged to the cost of production by allocating the full year’s holiday pay to overhead and charging it to production for the whole year. Alternatively, wages may be allocated at labour rates inflated to include holiday pay and other non-productive time costs. 4.6.4 Night shift premium Night shift work is normally paid at a rate above the day rate. If a night shift is customary there is no need to segregate the premium element: the whole cost will enter into the calculation of the general charge-out rate. Where night shift is temporary feature because of general pressure of work, it is charged against general factory overhead. If it is carried out at the customer’s request it is charged to the job. Page 5 of 12

4.6.5 Idle time Idle time should obviously be prevented as far as possible. It is important to analyse the causes of idle time so that necessary corrective action can be taken. There are three many causes of idle time: (a) Productive causes (eg, machine breakdown, power failure or time spent waiting for work, tools, materials or instructions); (b) Administrative causes (eg, surplus capacity, policy changes, unforeseen drop in demand); (c) Economic causes (eg, seasonal fluctuations in demand, cyclical fluctuations in demand, changes in demand because of tax changes). Some of these causes are controllable (and therefore ‘normal’), while others are uncontrollable (and are regarded as being ‘abnormal’). Controllable idle time is shown under a separate account and charged as an overhead, or charged to the department if it arose through the fault of that department. Uncontrollable idle time is charged directly to the costing profit and loss account. 4.6.6 Training time Wages paid during a period of training may be charged partly to the job and partly to production overhead. The fact that learners work more slowly than trained employees is offset by the learners’ lower rate of pay. Apprentices’ remuneration will be charged to a separate account. 4.6.7 Reworking of defective items Where they do not form a major consideration, costs of reworking can be included in direct wages and charged to the job. Where the amount is considerable a separate account is required and the cost will be treated as part of departmental overheads. 4.6.8 Supervisors’ wages Normally supervisors’ wages are treated as part of departmental overhead unless only a particular job is concerned. Where instruction is being given, the remuneration of instructors and supervisors may be included in training time. 4.6.9 Other allowances There are other costs within the labour cost structure that you should be aware of and they include payments for: (a) Dangerous environments – furnaces, underwater, quarries, dangerous substances. (b) Extremes of temperature – hot or cold. (c) Unhealthy conditions – dirty work for example. (d) Travel – remote sites or where a firm has moved its location, or rationalised its location. (e) Special apparatus – diving suits or shields.

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As a result of the Health and Safety at Work Act provisions, additional labour related costs may be incurred for protective clothing, uniforms, overalls, boots, gloves, goggles or head gear. 4.7.0 Labour Cost Control It is important for managers to ensure that labour costs are controlled in relation to the work done. 4.7.1 Helpful ratios Two general ratios can be calculated from the financial information normally available in management accounts. They are: (a) The ratio of labour costs (by category of labour, where possible) to the total value of output, i.e., total cost of production or sales value. This has to be interpreted in the light of changes in labour rates, material costs and the mix of products, and also of changes in selling prices where sales value is used; (b) The ratio indirect labour costs to direct labour costs. The normal figure of this ratio will vary according to the type of business. 4.7.2 Comparisons against budget In addition, for indirect labour in particular, a comparison of actual costs against budget should be made. 4.7.3 Data re-numbers The financial information should be supplemented by information relating to numbers of people, such as: (a) The ratio of indirect workers to direct workers; (b) The ratio of the actual number of people employed to budgeted numbers. 4.7.4 Other information In addition to explaining various statistics, the following types of information are helpful: (a) Overtime hours as a percentage of total hours available, supplemented by details of the reasons for overtime. (overtime cost as a percentage of total wage costs can also be used); (b) Idle time as a percentage of total paid time; (c) Absenteeism: hours absent from work in relation to normal working hours; (d) The labour turnover rate, supported by details of joiners and leavers. 4.7.5 Measuring efficiency Wherever possible the efficiency of working should be measured and reported. In the case of a single product business or department this can be expressed as units produced per hour worked. In other cases efficiency can be measured by comparing the productive time taken for particular operations against some predetermined standard or allowed time.

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Example 3 The following labour data for quarter 1 with 480 basic hours per worker is given: Department Assembly: Budgeted numbers Actual numbers Hours: Budget Actual basic Overtime Costs: Budgeted: (K3/hours) (K5/hours) Actual: Basic Over Time

Direct

Indirect

Idle

Absent

Leavers

10 9

1 1

0 0

0 0

0 2

4,800 4,000 420

480 480

0 20

0 300

K14,400 K2,400

K12,400 K1,953

K2,400

Assume: (a) Output 100,000 units at a cost of production K0.56 each = K56,000 (b) One unit represents 2.7 standard minutes Required Compute the relevant labour ratios from the given information. 1. (a) Assembly labour costs : total value of output K 16,753 1 = or 1 : 3.34 K 56,000 3.34 (b) Assembly indirect costs : direct costs 2,400 1 = or 1 : 5.98 14,353 5.98 2. Assembly

Direct costs Indirect

Actual cost K 14,353 2,400

3. (a) Indirect workers : Direct workers 1:9 (b) Actual numbers : Budgeted numbers Page 8 of 12

Budgeted cost K 14,400 2,400

Difference K 47 -

10 : 11 4. (a) Overtime as a percentage of total direct hours 420 x 100% = 9.5% 4,420 Reason: one member of staff short and business is unable to employ. (b) Idle time as a percentage of total paid direct hours 20 x 100% = 0.42% 4,740 (c) Absentee hours as a percentage of normal working hours 300 x 100% = 6.94% 4,320

(d) Labour turnover rate Leavers replaced averagenumber of employees For assembly:

1 9

x 100% = 11%*

*two left , one replaced during the period 5. Standard hours produced expressed as a percentage of time taken. 2.7 = 4,500 standard hours Output = 100,000 x 60 Therefore,

Efficiency =

4,500 4,420

x 100% = 101.8%

4.8.0 Labour Treated as a Fixed Cost Situations has developed where labour costs no longer relate to output due to the increase in machine related activity. With guaranteed earnings and allowances, much of the cost of labour is now fixed. You should recognise: (a) Basic hours of labour are fixed. (b) Basic labour rates are fixed. (c) Additional allowances, shift premiums, holiday and environment allowances will be fixed. The only variable amounts are likely to be: (a) Bonus payments (b) Overtime premium Example 4 A, B, C, D, E, and F are the operatives employed in a machine shop. G is the shop foreman and H is employed on materials handing duties. Page 9 of 12

Clock cards for week ended 30th April showed the following hours of attendance:

Monday A B C D E F G H

Tuesday 8 8 8 9 8 10 10 10

Wednesday 9 8 8 8 9 8 9 9

Thursday

8 8 8 8 10 9 10 10

Friday 10 8 8 8 9 8 10 10

9 8 8 9 8 9 9 9

The hours worked in excess of 8 on any day are paid at ‘time and a half’, such overtime being necessary to enable the firm to meet the general pressure for delivery of customers’ orders. Operatives’ time sheets show time spent as indicated below, any unallocated time being regarded as idle time. Production Job No.

A B C D E F

123

327

469

518

719

842

917

11 6 10 8 14

4 19 10 9 9 5

15 10 7 8 8

1 12 10 5 8

8 4 12 9 8

3 4 3 -

2 3 2 1

Shop Sweepin g 1 -

Machin e Repairs 3 -

Hourly rates of pay are: A K1.32; B K1.32; C K1.26; D K1.38; E K1.26; F K1.26; G K1.50; H K1.20. Required Prepare statement for the week ended 30th April showing (a) The gross wages of each employee; and (b) An analysis of the total wages paid to direct labour and to each of the overheads concerned.

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Solution A. GROSS WAGES STATEMENT

Employee

Hours Worked

A

44

Overtime Hours

Basic K 1.32

4 B C D

0.66

40 40 42

44

F

44

48

0.63

55.44 2.52

57.96

0.63

55.44 2.52

57.96

0.75

72.00 6.00

78.00

0.60

57.60 4.80

62.40

1.50 8

H

59.34

1.26 4

G

0.69

57.96 1.38

1.26 4

48

1.20 8

Remuneration K K 58.08 2.64 60.7...