• Measuring labour

activity
• Remuneration methods
Accounting for • Recording labour costs
labour • Labour turnover
• Accounting for labour
costs
 Syllabus learning outcomes
• Calculate direct and indirect labour costs.
• Explain the methods used to relate input labour costs to work done.
• Prepare the journal and ledger entries to record labour cost inputs and outputs.
• Describe different remuneration methods: time-based systems, piecework systems and individual and
group incentive schemes.
• Calculate the level, and analyse the costs and causes of labour turnover.
• Explain and calculate labour efficiency, capacity and production volume ratios.
• Interpret the entries in the labour account.
Overview

Labour costs

Methods of Labour
remuneration turnover

Measuring labour
activity

Accounting for
labour costs
Tackling the exam

Example Question
 Introduction
Just as management need to control inventories and operate an appropriate valuation policy in an attempt
to control material costs, so too must they be aware of the most suitable remuneration policy for their
organisation.
 Measuring labour activity 1
• Production and productivity are common methods of measuring labour activity.
• Production is the quantity or volume of output produced.
• Productivity is a measure of the efficiency with which output has been produced.
• An increase in production without an increase in productivity will not reduce unit costs.
 Measuring labour activity 2
Management will wish to plan and control both production levels and labour productivity.
Production levels can be raised as follows:

• Working overtime
• Hiring extra staff
• Sub‑contracting some work to an outside firm
• Managing the work force so as to achieve more output
 Measuring labour activity 3
Production levels can be reduced as follows:

• Cancelling overtime
• Laying off staff

Productivity, if improved, will enable a company to achieve its production targets in fewer hours of work,
and therefore at a lower cost.
 Measuring labour activity 4
• A standard hour is the number of units produced by one worker working in the standard way at the
standard rate for one hour.
• We will look at standard costs in more detail in Chapter 14.
 Question to consider
An employee makes 200 units of product A, 350 units of product B and 300 units of product C. The
standard time allowed per unit is:
Product A 4 minutes
Product B 2 minutes
Product C 3 minutes

Required
What are the standard hours produced by the employee (in hours)?
Answer
Standard hours produced:

Product A 200 × 4 = 800

Product B 350 × 2 = 700
Product C 300 × 3 = 900
2,400 mins ÷ 60 = 40 hours
 Measuring labour activity 5
There are three main productivity ratios:

• Production volume ratio =

Expected hours to make output
Hours budgeted

• Capacity ratio =
Actual hours worked
Hours budgeted
 Measuring labour activity 6

• Efficiency ratio =
Expected hours to make output
Actual hours taken

Productivity ratio = Capacity ratio × Efficiency ratio

 Question to consider
Barnes Co budgeted to make 13,000 standard units of output during a budgeted period of 26,000 hours
(each unit should take two hours).
During the period, the company actually made 14,000 units which took 35,000 hours.
Required
(a) What is the efficiency ratio?
(b) What is the capacity ratio?
(c) What is the production volume ratio?
Give your answers to one decimal place
 Answer
(a) Efficiency ratio =

(b) Idle capacity ratio =

(c) Production volume ratio =

 Remuneration methods 1
There are three main methods of labour remuneration – time work, piecework and bonus/incentive
schemes.

Time work

• Wages = hours worked × rate per hour

• Overtime premium = extra rate per hour for hours over and above basic hours
• Quality more important than quantity
• No incentive for employee performance improvement
 Remuneration methods 2
Piecework schemes

• Wages = units produced × rate per unit

• Guaranteed minimum wage
• Differential schemes pay higher rates for increased levels of productivity
• Output inspected carefully
 Remuneration methods 3
Bonus/incentive scheme

Examples:

• Employee paid more for higher productivity

• Increased profits shared between employer and employee
• Bonus schemes (group and individual)
• Profit-sharing schemes
• Incentive schemes involving shares
 Remuneration methods 4
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.

Advantages

• It is simple to calculate and easy to understand.

• It guarantees the employee a consistently high wage.
 Remuneration methods 5
Disadvantages

• Employees cannot earn more than the fixed hourly rate for their extra effort.
• There is no guarantee that the scheme will work consistently.
• Employees may prefer to work at a normal rate of output, even if this entails accepting the lower wage
paid by comparable employers.
 Question to consider
Normal working day 8 hours
Basic rate of pay $6 per hour
Standard time allowed to produce 1 unit 2 minutes
Premium bonuses 75% of time saved at basic rate

Required
What is the cost of producing 340 units in one day?
Answer
Standard time 340 × 2 mins 680 mins
Actual time 8 hrs × 60 mins 480 mins
Time saved 200 mins
Bonus 75% × (200 mins/60) × $6/hr $15
Basic 8 hr × $6 $48
$63
 Question to consider
A company pays its employees using a piecework scheme. The rates are as follows:
0–100 units per week $4 per unit
101–150 units per week $4.50 per unit
151–200 units per week $5 per unit
201+ units per week $5.50 per unit

Required
If an employee produces 163 units in week 48, what would their pay be for that week?
Answer
$
1st 100 units (100 × $4) 400
Next 50 units (50 × $4.50) 225
Remaining 13 units (13 × $5) 65
Week 48 pay 690
 Recording labour costs 1
• Attendance is recorded on an attendance record or clock card.
• Job time may be recorded on time sheets or job cards.
• Even though salaried staff are paid a flat rate monthly, they may be required to prepare timesheets.
• Timesheets provide management with information (eg product costs).
• Timesheet information may provide a basis for billing for services provided (eg service firms where
clients are billed based on the number of hours work done).
• Timesheets are used to record hours spent and so support claims for overtime payments by salaried
staff.
 Recording labour costs 2
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
• Idle time has a cost because employees will still be paid their basic wage or salary for these
unproductive hours and so there should be a record of idle time.
• Idle time ratio =  100%
 Labour turnover 1
Labour turnover is measured by the labour turnover rate
Labour turnover rate = Replacements
Average number of employees in period

Reasons for labour turnover include the following:

• Illness/accident
• Moving
• Marriage/pregnancy
• Better pay or career prospects elsewhere
 Labour turnover 2
• Costs of labour turnover can be classified as preventative or replacement costs.

• Preventative costs include provision of medical services, welfare services, pension schemes.

• Replacement costs include selection and replacement, training, more wastage due to inexperienced
new staff.

• Labour turnover may be reduced by offering satisfactory wages/hours/conditions, creating job

satisfaction.
 Labour turnover 3
Replacement costs

• Cost of selection and placement

• Inefficiency of new labour; productivity will be lower
• Costs of training
• Loss of output due to delay in new labour becoming available
• Increased wastage and spoilage due to lack of expertise among new staff
• The possibility of more frequent accidents at work
• Cost of tool and machine breakages
 Labour turnover 4
Preventative costs

• Cost of personnel administration incurred in maintaining good relationships

• Cost of medical services including check‑ups, nursing staff
• Cost of welfare services, including sports facilities and canteen meals
• Pension schemes providing security to employees
 Labour turnover 5
How to reduce labour turnover

• Paying satisfactory wages

• Offering satisfactory hours and conditions of work
• Creating a good informal relationship between members of the workforce
• Offering good training schemes and a well understood career or promotion ladder
• Improving the content of jobs to create job satisfaction
• Proper planning so as to avoid redundancies
• Investigating the cause of an apparently high labour turnover
 Question to consider
A company has 1,000 staff at the start of 20X3 and at the end this had reduced to 920 due to redundancies
being made.
100 staff took voluntary redundancy which was 20 more than the company had anticipated and these 20
employees were replaced.

Required
What is the labour turnover rate per year?
Answer

20
Labour turnover= ×100=2.08 %
(1,000 +920)÷ 2
 Accounting for labour costs 1
Labour costs can be classified as direct labour or indirect labour.

Examples of direct labour costs:

• Basic pay of direct workers

• Overtime worked at specific request of customers
• Overtime worked regularly by production department
 Accounting for labour costs 2
Examples of indirect labour costs:

• Basic pay of indirect workers

• Overtime premium
• Bonuses
• Employer's NIC (social security)
• Idle time cost
 Accounting for labour costs 3
• Accounting for labour costs is in the Wages control account
• Debit account with net wages paid and income tax/social security deductions
• Credit account with direct labour, indirect labour, overtime premium, shift allowance, sick pay, idle time
 Question to consider
Company X employs two types of labour: skilled workers, considered to be direct workers, and semi-skilled
workers considered to be indirect workers. Skilled workers are paid $10 per hour and semi-skilled $7.50
per hour. All employees work a standard 35 hour week. There are seven skilled workers and four semi-
skilled workers.
The skilled workers have worked 50 hours of overtime this week, 20 hours on a specific order and 30 hours
on general production.
The semi-skilled workers have worked 20 hours of overtime, 10 hours on a specific order at a customer's
request and the remaining 10 hours to meet general production requirements.
 Question to consider (cont'd)
All overtime is paid at time and a half.

Required
(a) What are the total direct labour costs for the week?
(b) What are the total indirect labour cost for the week?
(c) Complete the following account assuming the wages paid were cash of $3,580 after deductions of
$895.
Wages control account

$ $
Answer

Direct cost Indirect cost

$ $
Skilled workers:
Basic pay for normal hours worked
(7 × 35 × $10) 2,450
Basic pay for general overtime
(30 × $10) 300
Specific overtime
(20 × $10 × 1.5) 300
Overtime premium for general overtime
(30 × $10 × 0.5) 150
Answer (cont'd)

Direct cost Indirect cost

$ $
Semi-skilled workers:
Basic pay for normal hours
(4 × 35 × $7.50) 1,050
Specific overtime
(10 × $7.50 × 1.5) 112.50
General overtime
(10 × $7.50 × 1.5) 112.50
3,162.50 1,312.50
Answer (cont'd)

Wages control account

$ $
Bank – net pay 3,580.00 Work in process account
Deductions – PAYE/NIC 895.00 – direct labour 3,162.50
Production overheads
– indirect labour 1,312.50
4,475.00 4,475.00
Chapter summary 1
1. Introduction
 Some methods of remuneration for production staff:
— Time-based systems
— Piecework systems
— Bonus/incentive systems

2. Measuring labour activity

 Labour productivity is a measure of the efficiency with which output has
been produced.
 Companies will monitor productivity as part of their cost control procedures.
You need to be able to calculate:
— Efficiency ratios
— Capacity ratios
— Production volume ratios
 Chapter summary 2
3. Accounting for labour costs
 Labour costs will be split between direct and indirect costs and double entry will be used to record
these costs.

4. Labour turnover
 High labour turnover will cause increased cost to a business.