CHAPTER ACCOUNTING FOR DIRECT LABOR

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TOPICS
1. Definition of Labor
2. Wages Plan
3. Controlling Labor Cost
4. Accounting for Labor Cost

LEARNING OUTCOMES
1. Distinguish between and account for direct and indirect labor as they are
used in the production process.
2. Identify the three activities involved in accounting for labor.

TOPIC 1: DEFINITION OF LABOR

Labor is the physical or mental effort expended in manufacturing a product.

Labor cost is the price paid for using human resources. The compensation paid to
employees who engage in production related activities represents factory labor. The
principal labor cost is wages paid to production workers. Wage are payments made on
an hourly, daily, or piecework basis. Salaries are fixed payments made regularly for
managerial or clerical services. However, in practice, the terms “wages” and “salaries”
are often incorrectly used interchangeably.

Factory payroll costs are divided into – a) direct labor, and b) indirect labor
Direct
labor represents payroll costs that are allocated directly to the product and is debited to
the work in process account. Indirect labor costs of labor incurred for a variety of jobs
that are related to the production process but are considered either too remote or too
insignificant to be charged directly to production. Indirect labor costs are charged to the
factory overhead control account. Included as indirect labor are salaries and wages of
the factory superintendent, supervisors, janitors, clerks, factory accountants, and
timekeepers.

The accounting system of a manufacturer must include the following procedures for
recording payroll costs.

1. Recording the numbers of hours used in total and by job.

2. Recording the quantity produces by the workers.
3. Analyzing the hours used by employees to determine how time is to be charged.
4. Allocation of payroll costs to jobs and factory overhead account.

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5. Preparation of the payroll, including computation and recording of the employee
gross earnings, deductions, and net earnings

TOPIC 2: WAGES PLAN

There are different wage plans that are being used by companies. The plan
established by management is approved by the union and should comply with
regulation of government agencies. Some of these plans are: hourly-rate plan, piece-
rate plan, and modified wage plan.

Hourly-Rate Plan

Under this plan, a definite rate per hour is set for each employee. The
employees’
wages are calculated by multiplying the rate per hour by the number of hours worked.
The hourly-rate plan is simple to use but does not provide incentive for the employee to
achieve a high level of productivity. The employee is paid for merely “being on the job”.

Piece-Rate Plan

Under a piece-rate plan, earnings are calculated by multiplying the employee’s

output by the rate per piece. The plan provides an incentive for the employee to
produce more. However, the employee might sacrifice quality to maximize earnings.

Modified Wage Plan

This plan combines the features of hourly-rate and piece-rate plans. An example
of a modified wage plan would be to set a minimum hourly wage that will be paid by the
company even if an established quota of production is not attained by an employee. If
the established quota is exceeded, an additional payment per piece would be added to
the minimum wage level.

TOPIC 3: CONTROLLING LABOR COST

Maintain labor records is the responsibility of the time-keeping and payroll

departments. The time-keeping department accounts for the time spent by the
employees in factory. The payroll department computes each employee’s gross
earnings, the amount of withholdings and deduction, and the net earnings to be paid to
the employee.

The departmental responsibilities of time-keeping and payroll are carried out by

completing and maintaining the following forms and records:

Time-keeping Payroll
Clock cards Payroll records
Time tickets Employee’s earning records
Production reports Payroll summaries

TOPIC 4: ACCOUNTING LABOR COST

For all regular hourly employees, the hours worked should be recorded on a time

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ticket or individual production report. The time-ticket shows the employee’s starting
and
stopping time on each job, the rate of pay, and the amount of earnings. Individual
production reports are used instead of time tickets when labor costs are calculated
using piece rates. The time tickets and production reports are sent to payroll on a daily
basis. The pay rates and gross earnings are entered, and the reports are forwarded to
accounting. Cost accountants sort the time tickets and production reports and charge
the labor costs to the appropriate jobs or department and factory overhead. The
accounting department records the earnings in factory overhead ledger and on the
labor cost summary.

The labor cost summary is used as the source for making a general journal entry
to distribute payroll to the appropriate accounts. The entry is the posted to the control
accounts. Work in Process and Factory Overhead in the general ledger.

In preparing the labor cost summary from the tickets, it is important to separate
any overtime from an employee’s regular time because the accounting
treatment may be different for each type of pay. Regular time worked is charged to job
debiting Work in Process. Overtime may be charged jobs, to factory overhead or
allocated partly to jobs and partly to overhead. Overtime distribution depends upon the
conditions creating the need of overtime hours.

If an employee works beyond the regularly scheduled time but the employee is
paid at the regular hourly rate the extra pay is called overtime pay. If an additional rate
is allowed for the extra hours worked the additional rate earned is referred to as
overtime premium. The premium pay rate is added to the employee’s regular rate for
the additional hours worked. The premium rate will depend on the collective bargaining
agreement (CBA) between management and the union.

To illustrate how a payroll is calculated where overtime premium is a favor

assume
an employee regularly earns P 30 per hour for an 8-hour day. If called upon to work
more than 8 hours in a working day, the company will have to pay overtime premium
for hours worked in excess of 8 hours. Assuming the employee works 12 hours on
Monday, is paid 50% overtime premium (time-and-half) the earnings would be
calculated as follows.

Direct labor – 8 hours at P 30 P 240

Direct labor – 4 hours at P 30 P 120
Factory overhead (overtime premium – 4 x 15) P 60 P 180
Total earnings P 420

If the previously mentioned employee is paid a premium of 100% (double time)

the earnings would be.

Direct labor – 8 hours at P 30 P 240

Direct labor – 4 hours at P 30 P 120
Factory overhead (overtime premium-4 x 30) P 120 P 240
Total earnings P 480

With the proceeding illustration, the regular rate (240 + 120) will be charged to
Work in Process while the overtime premium (60 in the first illustration and 120 in the
second illustration) will be charged to Factory Overhead Control. By charging the
overtime premium to the factory overhead account, all jobs contract stipulated that it
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was a rush contract it would be appropriate to charge the premium pay to the job (Work
in Process) instead of to a factory overhead account.