MH Chapter - 3 - Labor Controlling and Accounting For Costs

CHAPTER-3
LABOR: CONTROLLING AND

ACCOUNTING FOR COSTS
Md.Musharof Hossain,Assistant Professor,DBA,IIUC

INTRODUCTION
• Labor cost represents the human contribution to production and is an important cost
factor requiring constant measurement, control, and analysis.
• Labor cost consists of basic pay and fringe benefits.
• The basic pay for work performed is called the base rate or job rate.
• A base rate should be established for each operation in a plant or office and grouped
by class of operation.
• An equitable wage rate or salary structure requires an analysis, description, and
evaluation of each job within the plant or office.
• Maintaining competitive wage rates and salaries facilitates the acquisition and
retention of quality personnel.

• Fringe benefits also from a substantial element of labor cost.
• Fringe costs, for example employer’s share of tax, holiday pay, vacation
pay, overtime premium pay, pension costs, and cost of living
adjustments, must be added to the base rate in order to arrive at the full
labor cost.
• While these fringe costs are generally included in overhead, they should
not be overlooked in management’s planning and control
responsibilities, in decision making analyses, or in labor-management
wage negotiations.

PRODUCTIVITY AND LABOR COSTS
• All wage payments are directly or indirectly based on and limited by the
productivity and skill of the worker.
• Therefore, proper motivation, control, and accounting for this human
cost factor is one of the most important problems in the management of
an enterprise.
• A cooperative and enthusiastic labor force, loyal to the company and its
policies, can contribute greatly toward efficient, low-cost operations.
• Wages are only element in employer-employee relations, however,
adequate records, easily understood and readily available, are an equally
important factor in harmonious relations between management,
employees, labor unions, government agencies, and the general public.
• Productivity may be defined as the measurement of production performance using
the expenditure of human effort as a yardstick.
• It is the amount of goods and services a worker produces.
• Perhaps productivity could also be described as the efficiency with which resources
are converted into commodities and/or services.
• Greater productivity can be achieved by better processes, improved or modern
equipment, or any other factor that improves the utilization of the work force.
• Changes in the utilization of a labor force often require changes in methods of
compensating labor, followed by changes in accounting for labor costs.
• The objective of productivity measurement is to provide management with a concise
and accurate index for the comparison of actual results with a standard of
performance.

• Productivity measurement should recognize the
individual contribution of factors such as
employees, plant and equipment used in
production, products and services utilized in
production, capital invested, and government
services utilized as indicated by taxes.

INCENTIVE WAGE PLANS
• In the modern industrial enterprise with mass production and many
employees, a worker’s wage is based on negotiated labor contracts,
productivity studies, job evaluations, profit sharing, incentive wage
plans, and guaranteed annual wages.
• Because all wages are paid for work performed, an element of incentive
is present in all wage plans.
• In contrast with pay by the hour, week, or month, an incentive wage plan
should reward workers in direct proportion to their increased output.

• To be successful, an incentive wage plan must:
• (1) be applicable to situations in which a worker can increase output,
• (2) provide for proportionately more pay for output above standard,
• (3) set fair standards so that extra effort will result in bonus pay,
• (4) result in immediate reward every payday.

PURPOSE OF AN INCENTIVE WAGE PLAN
• The primary purpose of an incentive wage plan is to induce a worker to
produce more, to earn a higher wage, and at the same time to reduce unit
costs.
• The plan seeks to insure greater output, to increase control over labor
cost by insuring more uniform unit costs, and to change the basis for
reward from hours served to work accomplished.
• Naturally, producing more in the same period of time should result in
higher pay for the worker.
• Because of the greater number of units produced, it should also result in
a lower cost per unit for factory overhead and labor cost combined.

• The lowering of conversion or manufacturing cost
resulting from an incentive wage plan should also be
analyzed in terms of differential or marginal or
incremental cost.
• The marginal revenue associated with the additional
output and the marginal cost of administering an
incentive wage plan are two factors that may influence
management’s decision to install a plan.

TYPES OF INCENTIVE WAGE PLANS
•Types are:
•(1) straight piecework plan
•(2) 100 percent bonus plan
•(3) Group bonus plan

(1) STRAIGHT PIECEWORK PLAN
• The simplest incentive wage plan.

• It pays the wages above the base rate for base rate for production above the standard.
• The production standard is computed in minutes per piece and is then translated into money
per piece.
• For example, if time studies determine that 2.5 minutes is to be the standard time required
for producing one unit, the standard rate is 24 pieces per hour. If a worker’s base pay rate is
$7.44 per hour, the piece rate is = 7.44/24= 0.31 per unit.
• You are given different units per hour (20,22,24,26,28,30 and 32 units per hour
respectively), guaranteed hourly rate is 7.44, overhead per hour 4.80. Calculate labor cost
earned per hour, labor cost per unit and conversion cost per unit.

SOLUTION
Units per hour (X)

(1) Units 20 22 24 26 28 30 32
(2) Guaranteed hourly rate $7.44 $7.44 $7.44 $7.44 $7.44 $7.44 $7.44
(3) Piece rate= 7.44/24=0.31 applicable when units are $0 $0 $0 $0.31 $0.31 $0.31 $0.31
more than 24 units per hour
(4) Earned per hour ($7.44+ (X-24)*$0.31) $7.44 $7.44 $7.44 $8.06 $8.68 $9.30 $9.92
(5) Labor cost per unit (4)÷(1) $0.372 $0.338 $0.310 $0.310 $0.310 $0.310 $0.310
(6) Overhead per hour $4.80 $4.80 $4.80 $4.80 $4.80 $4.80 $4.80
(7) Overhead per unit (6)÷(1) $0.240 $0.218 $0.200 $0.185 $0.171 $0.160 $0.150
(8) Conversion cost per unit (5)+(7) $0.612 $0.556 $0.510 $0.495 $0.481 $0.470 $0.460

(2) 100 PERCENT BONUS PLAN
• The 100 percent bonus plan is a variation of the straight piecework plan. It differs in that
standards are stated not in terms of money, but in time per unit of output.
• Instead of a piece per piece, a standard time is allowed to complete a job or unit, and the
worker is paid for the standard time at the hourly rate if the job or unit is completed in
standard time or less.
• Thus, if a worker produces 100 units in an 8-hour shift and the standard time is 80 units per
shift (or 10 units per hour), the worker would be paid the hourly rate for 10 hours. In other
variations of the 100 percent bonus plan, savings are shared with the supervisor and/or the
company.
• Each payroll period, an efficiency ratio must be figured for every worker before earnings can
be computed.
• The efficiency ratio multiplied by the worker’s base rate results in the hourly earnings for
the period.

• For example, the standard production is 15 units per hour.
There are six workers, Abrams, Gordon, Hanson, Jonson,
Stowell and Wiebold and hours worked by each worker is
given by 40, 40, 40, 38, 40 and 40 hours respectively. Units
produced by each worker is given by 540, 660, 800, 650, 750
and 810 units respectively. Base rate is $7.50 per hour for
Abrams, Gordon, Hanson, $7.60 per hour for Jonson, $8.00
per hour per Stowell and $7.72 per hour for Wiebold.
Overhead rate per hour is given by $5.40.
• Calculate total labor cost, labor cost per unit, overhead cost per
unit and conversion cost per unit.

SOLUTION
Worker
Worker Abrams Gordon Hanson Jonson Stowell Wiebold
(1) Hours worked 40 40 40 38 40 40
(2) Actual output in units 540 660 800 650 750 810
(3) Standard units: 15 units per hour × (1) 600 600 600 570 600 600
(4) Efficiency ratio (2) ÷ (3) 90% 110% 133% 114% 125% 135%
(5) Base rate $7.50 $7.50 $7.50 $7.60 $8.00 $7.72
(6) Base rate × Efficiency ratio (not applicable when - $8.250 $9.975 $8.684 $10.000 $10.422
efficiency ratio is 100 percent or less than 100%)
(7) Total earned (total labor cost) $300.00 $330.00 $399.00 $329.23 $400.00 $416.88
(8) Labor cost per unit (7) ÷ (2) $0.5556 $0.5000 $0.4988 $0.5065 $0.5333 $0.5147
(9) Overhead per hour $5.40 $5.40 $5.40 $5.40 $5.40 $5.40
(10) Overhead per unit (9) ÷ (2) $0.4000 $0.3273 $0.2700 $0.3157 $0.2880 $0.2667
(11) Conversion cost per unit (8) + (10) $0.9556 $0.8273 $0.7688 $0.8222 $0.8213 $0.7814

(3) GROUP BONUS PLAN
• Industry uses a great variety of incentive wage plans, some of which depend upon a superior
productive performance of a whole department or an entire factory.
• Factory operations often require employees to work in groups or crews using large machines.
• Although the work of each employee is essential to the machine operation, it is frequently impossible
to separate the work of one member of a crew.
• A worker on an assembly line cannot increase output without the cooperation of the entire group.
Group bonus plans have proven successful in such situations.
• It encourages production at rates above a minimum standard.
• Each worker in the group receives an hourly rate for production up to the standard output. Units
produced in excess of the standard are regarded as time saved by the group, and each worker is in
effect paid a bonus earned by the group is divided among the group members in accordance with their
respect base rates.
EXAMPLE
• A crew of 10 workers uses costly equipment, and each is paid $10 an hour for
a regular 8-hour shift. Standard production is 50 units per hour, or 400 units
per shift; overhead is $320 per 8-hour shift, or $40 per hour.
• Units produced in 6 days are given as follows: Saturday: 350 units, Sunday:
400 units; Monday: 425 units; Tuesday : 450 units; Wednesday : 475 units and
Thursday : 500 units.
• Calculate total group earning for 6 days, labor cost per unit, overhead cost per
unit and conversion cost per unit.

SOLUTION
Day
Day Saturday Sunday Monday Tuesday Wednesday Thursday
(1) Units produced 350 400 425 450 475 500
(2) Standards hours for units produced, (1) ÷ 50 units 70 80 85 90 95 100
per hour × 10 workers
(3) Actual hours, 10 workers × 8 hours per shift 80 80 80 80 80 80
(4) Regular group wage, 8 hours per shift×10 workers × $ 800 $ 800 $ 800 $ 800 $ 800 $ 800
$10 per hour
(5) Time saved (2)-(3) - - 5 10 15 20
(6) Bonus (5) × $10 - - $50.00 $100.00 $150.00 $200.00
(7) Total group earnings or total labor cost (4)+(6) $800.00 $800.00 $850.00 $900.00 $950.00 $1000.00
(8) Labor cost per unit (7) ÷ (1) $2.286 $2.000 $2.000 $2.000 $2.000 $2.000
(9) Overhead cost day $320.00 $320.00 $320.00 $320.00 $320.00 $320.00
(10) Overhead per unit (9) ÷ (1) $0.914 $0.800 $0.753 $0.711 $0.674 $0.640
(11) Conversion cost per unit (8) + (10) $3.200 $2.800 $2.753 $2.711 $2.674 $2.640
TIME STANDARDS VIA LEARNING CURVE THEORY
• Incentive wage plans assume that monetary bonuses will motivate workers to
achieve higher productivity rates.
• In turn, the greater the output, the lower the conversion cost per unit.
• The learning curve theory stipulates that every time the cumulative quantity of units
produced is doubled, the cumulative average time per unit is reduced by a given
percentage.
• If it is assumed that this reduction is 20 percent, it means that the second unit
requires 80 percent of the cumulative average time per unit required for the first unit;
the fourth unit, 80 percent of the second; the eighth unit; 80 percent of the fourth,
and so on.

• Based on this theory, the following table of the values for an 80% learning curve can
be computed, assuming that 10 direct labor hours are required to produce the first
unit:
units X Cumulative average required labor = Estimated total hours needed to perform the
hours per unit task
1 10.0 hours 10.0 hours
2 8.0 (10.0x80%) 16.0
4 6.4 (8.0x80%) 25.6
8 5.1 (6.4x80%) 40.8
16 4.1 (5.1x80%) 65.6
32 3.3 (4.1x80%) 105.6
64 2.6 (3.3x80%) 166.4

ORGANIZATION FOR LABOR COST
ACCOUNTING AND CONTROL
• Labor costing procedure involve:

• (1) the employment history of each worker-date hired, wage rate, initial assignment,
promotions, tardiness, sickness, and vacations.
• (2) adequate information for compliance with union contracts, social security laws,
wage and hour legislation, income tax withholding, and other local and central
government requirements.
• (3) the establishment of labor time and cost standards for comparative purposes.
• (4) productivity in relation to type of wage payment, creating the best system of
compensation for each kind of work.

• (5) each employee’s time worked, wage rate, and total earnings for each
payroll period.
• (6) the computation of deductions from gross wages for each employee.
• (7) the output or accomplishment of each employee.
• (8) the amount of direct labor cost and hours to be charged to each job,
lot, process, or department, and the amount of indirect labor cost. The
direct labor cost or hours information may be used as a basis for factory
overhead application.
• (9) total labor cost in each department for each payroll period.
• (10) the compilation of cumulative earnings and deductions detail for
each employee.
LABOR PERFORMANCE REPORT
• Production schedules, performance standards, and labor budgets represent plans and
expectations, but effective control of labor efficiency and costs depends upon
meaningful and timely performance reports sent to departmental heads and
supervisors who are directly responsible for departmental production.
• labor performance reports are designed to compare budgets and standards with
actual results attained, thereby pointing to variances from planned performance.
• The departmental direct labor cost report, the plant wide labor cost report issued
weekly or monthly, the daily performance report for labor, and daily idle time reports
are the media used to provide supervisors and plant managers with information
needed for effective cost control.

PROBLEMS

END
OF
CHAPTER 3

MH Chapter - 3 - Labor Controlling and Accounting For Costs

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CHAPTER-3

LABOR: CONTROLLING AND

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

• The simplest incentive wage plan.

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Units per hour (X)

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

2 8.0 (10.0x80%) 16.0

4 6.4 (8.0x80%) 25.6

8 5.1 (6.4x80%) 40.8

16 4.1 (5.1x80%) 65.6

32 3.3 (4.1x80%) 105.6

64 2.6 (3.3x80%) 166.4

• Labor costing procedure involve:

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

Md.Musharof Hossain,Assistant Professor,DBA,IIUC

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