Chapter 4- Accounting for Labor

Learning Objectives

Upon completing this chapter, you should be able to:

• Discuss the activities involved in the labor control;

• Define labor turnover, its causes, effects and benefits of labor turnover;
• Distinguish between and account for direct and indirect labor as they are used in the production process;
• Discuss how idle time, overtime, shift premiums and other benefits are accounted;
• Describe the common payroll deductions required by government;
• Explain how salaries and wages and related payroll deductions are recorded; and
• Identify three activities involved in accounting for labor.

INTRODUCTION

One of the essential element of the manufacturing costs is the labor cost. Labor is the physical or mental
effort expended in manufacturing a product while labor cost is the price paid for using human resources. Factory labor
is the compensation paid to employees who engage in production. Wages are payments made an hourly, daily or
piecework basis. On the other hand, salaries are payments made regularly for managerial or clerical services.

LABOR CONTROL
Since labor cost forms the significant percentage of the total cost of product in a manufacturing and service
organization, management should have appropriate control on this. The following controls should be observed in labor
management:
• Periodic verification of employee information with the records of personnel department
• Authorization and verification of any changes in employee records such as name change, transfer, promotion,
change in rate, etc.
• Proper authorization of overtime work
• Verification of calculation of incentive scheme
• Restricting payment of wages to any worker on behalf of the absentee worker
• Payment of wages through bank deposits or checks instead of cash

Company must establish a good internal control in order to eliminate unnecessary cost due to payment of
fraudulent wages. There must be proper authorization, that is duties between time keeping and payroll processing be
segregated. Also, time reports should be reconciled with the attendance records.
ATTENDANCE AND TIME RECORDING
Labor cost must be properly controlled since the cost of labor depends on the time, like workers who are
paid either on a monthly, hourly, or daily basis. In order to properly control this, there must have a policy for logging
in and reporting of attendance.

Attendance Tracking
Attendance are tracked by using a logbook called attendance register that a worker or employee must sign
or log in before entering and leaving the office or company premises. Entries are then transferred to individual
attendance records by the timekeeping staff. Attendance record is used for calculating the salaries and wages of the
employees to comply with the labor laws while time.

Some organization uses time clock that is installed at the entrance of the facility. A worker or employee
inserts his/her card inside the clock which prints the arrival or departure time on the card. Timekeeping staff then
collects all the cards on daily or weekly basis and then transfers the entries to the attendance records. In both cases, it
is necessary that a timekeeping staff is present when someone signs the attendance register or when punching the time
card in order to supervise the procedure. The latest timekeeping systems include biometric time clock that uses finger
print or hand recognition biometric technology and eliminates the need for manual time cards. This system provides
optimum payroll accuracy at work location.
Time keeping department is responsible for maintaining labor records for the time spent by the employees
in the factory.

Time Recording

Time recording assists the organization in allocating the time to various jobs, activity or process, or
overhead. The following documents are used to monitor the recording of time to specific job, activity, or process:
• Job card or job ticket or time ticket. This is used to record the time spent by the operator on each job.
• Daily or weekly time sheet. This is commonly used when a worker has a number of small jobs during
the normal working hours. The workers record the number of hours incurred to each jobs on a daily basis
or weekly basis.

The respective department supervisors should initiate the individual time ticket or time sheet to ascertain the
correctness of the time report.

The payroll department computes each employee’s gross earnings, the amount of withholdings and
deductions, and the net earnings to be paid to the employee.
 Exhibit 4.1- Sample Weekly Employee Time Sheet

LABOR TURNOVER

Labor turnover refers to the change in the labor force during a specified period. It represents a proportion of
the employees who leave either through resignation, dismissal, or attention, to the number of employees on payroll
during the period. High labor turnover ratio reflects an increase in cost and decrease in productivity. Labor turnover
varies with different group of employees and measurement is more useful when using disaggregated data such as by
cost center or department or according to certain factors such as length of service, age, or occupation.

Measuring Labor Turnover

Labor turnover is measured using three methods:

1. Separation method. This is the simplest method with calculates the number of separations as a
percentage of the number employees during the same period.

No. of separations during the period

Labor turnover = X 100
Ave. No. of employees during the period
 2. Replacement method. This method calculates the number of new replacements as a percentage of the
number employees during the same period. New recruitments for project expansion are not included in
the total replacements.
No. of replacements during the period
Labor turnover = X 100
Ave. No. of employees during the period

3. Flux method. This is the combination of two methods above. It calculates the total separations and
replacements as a percentage of the number employees during the same period.

(No. of separations + no. of replacements during the period)

Labor turnover = X 100
Ave. No. of employees during the period

Example 1:

Assume the following workers on payroll for Minda Company in 2019:

No. of employees, January 1 2,600

No. of employees, December 31 2,800
Employee resignations 50
Employee discharged 140
Employee recruited (of these, 60 workers 450
were recruited because of leavers and the rest were
recruited due to the expansion plan)

The average no. of employees during the year is 2,700, which is calculated as: (2,600 + 2,800)/2

The labor turnover ratio is then calculated as follows:

Method of Calculation Labor turnover rate

Separation method (50 + 140) X 100 7.04%

2,700

Replacement method 60 2.22%

2,700 X 100

Flux method (50 + 140 +60) X100 9.26%

2,700
Causes, Effects, and Benefits of Labor Turnover
Labor turnover is caused by a number of factors. While some of them are mainly personal causes such as
change in employee status such as marriage, relocation, or death, some are controllable by the organizations. Among
these are the following:
• Dissatisfaction with job or inadequate compensation
• Poor morale and low levels of motivation within the workplace
• Bad relationship with co-workers or superiors
• Unsatisfactory working conditions and facilities
• Lack of incentive and promotion
• Lack of employee welfare activities

In order to lessen the labor turnover rate, management should perform necessary remedial action since there
are additional costs associated with high labor turnover rate, such as:
• In order to find a replacement, recruitment costs will be incurred
• There will be additional training and supervision costs for new hires
• Possible loss of customer goodwill
• Lower production rate and low profit

However, labor turnover at certain level, offers benefits to the organization such as:
• There will be new ideas, skills, and enthusiasm to the labor force
• Young ones or the new replacement are amenable to change in the systems and processes
• Labor turnover can help reduce its workforce when there is a low utilization rate and a number of redundant
tasks.

ACCOUNTING FOR LABOR COST

Direct and Indirect Labor

Factory payroll costs are divided into direct and indirect labor. Direct labor represents the time of workers
who physically convert raw materials into finished goods. It is the portion of payroll cost that is directly traceable to
the product, job or activity; hence, it is charged to the work in process inventory account. Indirect labor represents
time spent for a variety of jobs related to the production process but are considered either too remote or too
insignificant to be charged directly to production. These are other general workers for running the factory and cannot
be directly identified with job, activity or process. Examples are salaries paid to cleaning staff, maintenance staff,
security personnel, etc. Indirect labor is charged to factory overhead control.
Idle Time
These are portion of hours paid but not utilized in the production. It is subdivided into normal idle time and
abnormal idle time and caused by the following:

Normal idle time

• Time lost in setting up the machine, tools, change over from one job or another
• Stoppage of production due to machine breakdowns, material shortage, and power failure

Abnormal idle time

• Excessive machine breakdown
• Excessive internal power failure
• Excessive waiting time for materials, instructions, etc.
• Excessive time incurred to rectify detectives
• Labor strike, lockout, fire, woods, etc.

It is important to segregate idle time arising from normal from those arising from abnormal situation because
the treatment is not the same. Normal idle time is charged to factory overhead. However, some idle time of workers
directly involved in the job, activity, or process such as time spent of setting up the tools or machine or change over,
can be added as part of direct labor cost by inflating the hourly or daily rate. However, labor costs relating to abnormal
idle time is treated as period costs, thus charged to operations.

Example:
If the daily wage of a direct worker is P1,800 for 8 hours and idle time is normally 10% of total hours, the
direct labor cost is P250 per hour as calculated below:

Regular rate = Direct labor rate per hour

Applicable work hours less idle time

P1,800 = P250 per hour

8 hours – 10% (or 7.2 hours)

Assume the following data for Chin Company:

Regular rate P100 per hour

Normal workweek 40 hours
Idle time due to normal machine breakdown 4 hours

If the labor cost is not inflated as a result of normal idle time, the breakdown of labor cost is as follows:
 Direct labor (P100 x 36 hours) P3, 600
Factory overhead (P100 x 4 hours) 400
Labor cost for the week P4, 000

Overtime
Overtime premium is the amount paid for the the overtime worked, in excess of the normal wage rate. In
general, it is treated as factory overhead, which will be recovered by way of overhead absorption rates. However, if
the overtime premium is paid to complete the job at the request of the customer (rush orders), it is charged to the
particular job or work in process. If overtime premium is paid due to abnormal causes, it should be charged to profit
or loss.
Assume the following data:
Regular rate P100 per hour
Overtime pay in excess of 40 hours P150 per hour
Normal workweek 40 hours
Actual hours work 46 hours
Idle time None

Overtime premium is charged to factory overhead control.

The breakdown of labor cost is as follows:

Direct labor (P100 x 46 hours) P4, 600

Factory overhead (P50 x 6 hours) 300
Labor cost for the week P4, 900

The following entry is recorded to distribute the payroll:

Debit Credit

Work in process inventory P4, 600

Factory overhead control 300
Payroll P4, 900

Only the overtime premium is charged to factory overhead and not the entire overtime cost of P900 (or P150 X 6
hours).

If the entire labor cost, including overtime premium, is treated as direct labor, the entry to distribute the payroll is:

Debit Credit

Work in process inventory P4, 900

Payroll P4, 900
Shift Premiums

Shift premiums may be paid to employees who do not work the regular day shift. These premiums for
inconvenient hours rather than increased productivity. Hence, shift premiums should be charged to factory overhead
control.

Bonus, Vacation, and Holiday Pay

Bonus pay, vacation pay and holiday pay are gradually earned during the time the employee is on the job.
Therefore, a portion of this liability should be accrued each payroll period that the employee is on the job. Amount
pertaining to factory employees is charged to factory overhead control.

Example:

Assume that a factory supervisor earns P3, 000 per week (based on five day work week) and is
entitled to a 10 paid holidays, two week vacation and P5, 000 bonus. For each of the 50 weeks that the supervisor
works (52 week less 2 weeks of vacation), the factory overhead control account would be debited for P332. If the
supervisor is a sales worker, selling or general expenses would be debited.

Holiday pay

Salary per day (P3, 000 / 5 days) P 600

Number of paid holidays 10
Total holiday pay P6, 000
Divided by: Number of working week 50
Holiday pay expense per week P 120

Vacation pay:

Salary per week P3, 000

X Number of paid holidays 2
Total vacation pay P6, 000
Number of working week 50
Vacation pay expense per week P 120

Bonus:
Year-end bonus P5, 000
Number of working week 50
Bonus expense per week P 100
 Total expense per week P 340

The following entry is made to record the weekly accrual:

Debit Credit
Factory overhead control P340
Accrued expenses P340

Employee Benefit Plan

An organization may provide different type of employee benefit plans or retirement benefits for all qualified
employees. The employee should accrue systematically the total estimated retirement cost from the date the plan
started to the date the employee retires. Current benefits for factory employees are part of the cost of production and
may be charged to factory overhead control, or they may be charged to general or administrative expenses under the
premise that the retirement costs are beneficial to the company as the whole.

Payroll Deductions and Contributions

The following are the common payroll deductions required by the government:

• Withholding tax on compensation. This is the tax withheld by the employer from the employee
compensation arising from employer-employee relationship. It is calculated based on tax table provided by
the Bureau of Internal Revenue.
• Philippine Health Insurance Corporation (Phil Health) Contribution. Phil health is a government owned
and controlled corporation that provide social health insurance coverage for all Filipinos. Premium
contributions are shared equally by the employee and the employer. Total premium is determined using the
table of contributions provided by Phil health.
• Home Development Mutual Fund (HDMF) contribution. HDMF is popular known as PAG-IBIG, which
stand for Pagtutulungan sa Kinabukasan, Ikaw, Bangko, Industriya at Gobyerno. It was established to
improve the quality of life of its member through savings system and to motivate them to better plan and
provide for their housing needs. Both employee and employer have their equivalent share in the HDMF
contributions.
• Social Security System SSS Contribution is a social insurance program for workers in the Philippine private
sector. Members can avail many benefits in case of sickness, maternity, retirement, disability or death. Both
the employee and the employer contribute to the SSS based on the table contributions provided by SSS.

Recording of Payroll

In recording payroll, the following steps should be followed:

1. Gross payroll. Gross payroll is the total amount of compensation before any deductions, contributions, and
withholdings. This is debited to the payroll account, which acts as a clearing account before it is distributed
to various factions or divisions.
2. Employee deductions and contributions. Employee deductions and contributions (withholding tax, SSS,
Phil health, and HDMF) should be credited to appropriate liability accounts.
3. Net pay. The difference between gross payroll and all deductions and employee contributions represents net
pay of the employees. This is credited to accrued salaries (liability account).
The following is the journal entry to record the payroll:
Debit Credit
Payroll (gross) XXX
Withholding taxes payable XXX
SSS contributions payable XXX
Phil health contributions payable XXX
HDMF contributions payable XXX
Accrued salaries (net) XXX

4. Distribution of gross payroll. The payroll account is allocated to various functions or divisions with
corresponding credit to payroll to close this account. Amount pertaining to direct labor is charged to work in
process inventory, while indirect labor is charged to factory overhead control. Sales salaries and
commissions, general and administrative salaries are recorded using the appropriate operating expense
accounts.

Debit Credit

Work in process inventory XXX

Factory overhead control XXX
Selling and general expenses XXX
Administrative expenses XXX
Payroll XXX
5. Employer’s payroll contributions. Contributions of employer in SSS, EC, Phil health, and HDMF do not
affect the net pay of the employees. These are additional costs of employer, hence recorded as an operating
expense except for the amounts pertaining to factory workers (direct and indirect labor) which should be
charged to factory overhead control. The corresponding credit is to a liability account.

Debit Credit
Factory overhead control XXX
Selling and general expenses XXX
 Administrative expenses XXX
SSS contributions payable XXX
EC contributions payable XXX
Phil health contributions payable XXX
HMDF contributions payable XXX

6. Payment of accrued payroll. The accrued payroll should be debited when actual payment is made to the
employees.
Debit Credit
Accrued salaries XXX
Cash XXX

7. Remittance to employer and employee contributions. When the employer remits the contributions to the
agencies after the payroll period, the liability is debited with corresponding credit to cash.

Debit Credit
SSS contributions payable XXX
Phil health contributions payable XXX
EC contributions payable XXX
HDMF contributions payable XXX
Withholding taxes payable XXX
Cash XXX

Example:
Bravo Corporation started its operations on March 1st (Monday). Employees work from Monday to Friday based on a
40-hour work week. Payroll is prepared on a bi-monthly basis and paid every 15th and 30th of the month. Assume
further that there are no holidays or special holidays during the month.

Gross salaries and wages:

Headcount Daily rate Total per day Allocation

Direct labor 32 P750 P24, 000 60%
Indirect labor 8 600 4, 800 12%
Selling 10 800 8,000 20%
Administrative 5 640 3, 200 8%
55 P40, 000 100%
Deductions and contributions:
 Employee Employer

Withholding tax 15% -

SSS contributions 3% 7%
Phil health contributions 1.25% 1.25%
HDMF contributions 2% 2%
EC contributions (P10/month per employee) - 550

The journal entries to record the payroll are:

Date Account Debit Credit

March 15 Payroll 400,000 (P40,000 x 10 days)

Witholding tax payable 60,000 (P400,000 x 15%)
SSS Contribution Payable 12,000 (P400,000 x 3%)
Philhealth Contribution Payable 5,000 (P400,000 x 1.25%)
HDMF Conribution Payable 8,000 (P400,000 x 2%)
Accrued Payroll 315,000
To record the payroll for the first half of the month

Accrued Payroll 315,000

Cash 315,000
To record the payment of payroll for the first half of the month

March 27 Payroll 400,000 (P40,000 x 10 days)

Witholding tax payable 60,000 (P400,000 x 15%)
SSS Contribution Payable 12,000 (P400,000 x 3%)
Philhealth Contribution Payable 5,000 (P400,000 x 1.25%)
HDMF Contribution Payable 8,000 (P400,000 x 2%)
Accrued Payroll 315,000
To record the payroll for the second half of the month

Accrued Payroll 315,000

Cash 315,000
To record the payment of payroll for the second half of the month

March 31 Payroll 120,000 (P40,000 x 3days)

Withholding tax payable 18,000 (P120,000 x 15%)
SSS Contribution Payable 3,600 (P120,000 x 3%)
Philhealth Contribution Payable 1,500 (P120,000 x 1.25%)
HDMF Contribution Payable 2,400 (P120,000 x 2%)
Accrued Payroll 94,500
To record accrual of payroll for 3 days

Work in Process 552,000 (P920,000 x 60%)

Factory Overhead 110,400 (P920,000 x 12%)
Selling Expenses 184,000 (P920,000 x 20%)
Administrative Expenses 73,600 (P920,000 x 8%)
Payroll 920,000
To record distribution of payroll.
 Factory Overhead 68,296 (P662,400 x 10.25%) +(P10 x 40)
Selling Expenses 18,960 (P184,000x 10.25%) +(P10 x 10)
Administrative Expenses 7,594 (P73,600 x 10.25%) +(P10 x 5)
SSS Contribution Payable 64,400
Philhealth Contribution Payable 11,500
EC Contributions Payable 550
HDMF Contribution Payable 18,400

The summarized payroll information for the month of March is:

Indirect
Direct Labor Labor Selling Admin Total
32 8 10 5 55

552,000 110,400 184,000 73,600 920,000

Withholding tax payable(15%) 82,800 16,560 27,600 11,040 138,000

SSS Contribution Payable (3%) 16,560 3,312 5,520 2,208 27,600
Philhealth Contribution Payable (1.25%) 6,900 1,380 2,300 920 11,500
HDMF Contribution Payable (2%) 11,040 2,208 3,680 1,472 18,400
434,700 86,940 144,900 57,960 724,500

SSS Contribution Payable(7%) 38,640 7,728 12,880 5,152 64,400

Philhealth Contribution Payable (1.25%) 6,900 1,380 2,300 920 11,500
EC Contributions (P10 per head) 320 80 100 50 550
HDMF Contribution Payable (2%) 11,040 2,208 3,680 1,472 18,400
56,900 11,396 18,960 7,594 94,850

REVIEW QUESTIONS

1. What is the purpose of the employee time sheet?

2. What is labor turnover and what causes labor turnover?
3. What are the common activities involved to control the cost of labor?
 4. What are the common payroll deductions required by government and how they affect the calculation of
net pay?
5. Discuss the accounting treatment for idle time, overtime, shift premiums.

MULTIPLE CHOICE QUESTIONS

1. Which of the following statement is true:

a. Labor cost is a prime cost of production.
b. Labor cost is committed cost.
c. Time spent by a direct worker can be identified with a specific job or process.
d. All of the above

2. Timekeeping is different from timebooking because:

a. timekeeping is a technique of recording the time
b. timekeeping is the analysis of the time spent by workers, while timebooking is the time spent by
workers on different jobs
c. timekeeping is the time spent by workers while timebooking is the analysis of time spent by workers
d. none of the above

3. [AICPA] A direct labor overtime premium should be charged to a specific job when the overtime is
caused by the:
a. increased overall level of activity.
b. customer’s requirement for early completion of job.
c. management’s failure to meet the established production schedule
d. management’s requirement that the job be completed before the annual factory vacation closure.

4. Idle time is:

a. time spent by workers to take coffee break.
b. time spent by workers on their jobs.
c. time spent by workers in the factory.
d. The difference between the time spent on the job and the time for which the workers are paid.

5. Labor turnover is:

a. the average labor force in the organization.
b. the efficiency of the labor force in a given period.
c. the cost of labor incurred in a given period.
 d. the change in the labor force.

6. Matt incurred direct labor overtime premium of P50,000 during the month of June 2019. As the
company’s cost accountant, you charge this overtime premium to specific job because it was precipitated
by:
a. the customer’s wanting the jobs completed earlier.
b. increased production leading to the Christmas season.
c. plant manager’s failure to include the jobs in the production schedule of the preceding month.
d. plant manager’s decision to complete all jobs prior to annual maintenance shutdown in December.

7. Which of the following can considered as an abnormal cause of the idle time?
a. machine breakdown
b. shift change time
c. worker’s personal time (lunch, coffee break, etc.)
d. all of the above

8. Labor turnover means:

a. turnover generated by labor
b. number of employees leaving the company
c. both A and B
d. none of the above

9. Costs associated with the labor turnover can be categorized into:

a. retaining costs
b. replacement costs
c. both A and B
d. none of the above

10. Allotment of the whole item of cost center or cost unit is known as:
a. cost apportionment
b. cost allocation
c. cost absorption
d. machine hourly rate

11. Which of the following is not an avoidable cause of labor turnover:

a. Job satisfaction
b. Lack of training facilities
 c. Low wages and benefits
d. Disability, making a worker unfit for work

12. Compute labor turnover rate using replacement method:

Employee resignation 8
Employees recruited 5
Average number of workers 20
a. 15.0%
b. 25.0%
c. 40.0%
d. 65.0%

13. Compute labor turnover rate using flux method from the given data:
No. of separations 8
No of replacements 15
Average number of workers 40
a. 17.50
b. 20.0%
c. 37.5%
d. 57.5%

14. Compute labor turnover rate using separation method from the given data:
No of separations 20
Employees recruited 5
Average number of workers 60
a. 8.3%
b. 25.0%
c. 33.3%
d. 41.6%

15. Canada Company provided the following information for the most recent fiscal year:
Raw materials purchased P 90,000
Beginning raw materials inventory 150,000
Ending raw materials inventory 175,000
Factory overhead (including P30,000 of indirect materials
and P80,000 of indirect labor) 310,000
 Total manufacturing cost 620,000
How much is the direct labor cost?
a. P245,000
b. P275,000
c. P345,000
d. P355,000

16. Aoyama Corporation is local manufacturer that uses a job order costing. Manufacturing overhead is
applied using a predetermined rate based on direct labor cost. The cost ledger shows the following
information for the month of August:

Work in Process Inventory

Balance, August 1 P250,000 Goods manufactured P296,000
Materials used 120,000
Direct labor 100,000
Applied FOH 80,000

Aoyama had three outstanding jobs in ending work in process that are expected to be
Delivered in the following month:
• Job #108 with direct materials of P35,000 and direct labor of P20,000
• Job #109 with direct materials of P45,000 and direct labor of P25,000
• Job #110 with applied overhead of P28,000
The total labor cost charged to Job #110 during the month was:
a. P22,400
b. P35,000
c. P55,000
d. P80,000
SSS CONTRIBUTION TABLE
INCOME TAX TABLE