LABOR: CONTROLLING AND ACCOUNTING FOR COSTS

Intended Learning Outcomes:

At the end of the lesson, the learner will be able to:

1. Discuss the importance and nature of productivity, and productivity’s relationship to labor
costs;
2. Explain how labor efficiency and productivity are measured;
3. Define labor turnover and how it is measured;
4. Describe the causes, effects and benefits of labor turnover;
5. Discuss how idle time, overtime, shift premiums and other benefits are accounted for in
determining the labor cost to be charged to the product;
6. Describe the common payroll deductions required by government; and
7. Explain how salaries and wages and related payroll deductions are recorded.

LABOR CONTROL

Labor cost is a significant element of cost. This represents the salaries and wages paid to the workers or
employees of the firm. To achieve profitability, management aims to keep the labor cost low or balance
the labor cost with profitability. Establishing a good internal control of labor is important to avoid
fraudulent payment of wages. Time reports should be reconciled with the attendance records. There
must be proper segregation of duties between time-keeping and payroll processing.

The following controls should be observed in labor management:

1. Periodic verification of employee information with the records of HR Dept.

2. Authorization and verification of any changes in employee records such as name change,
transfer, promotion, change in rate, etc.
3. Proper authorization of overtime work.
4. Verification of calculation of incentive scheme.
5. Restricting payment of wages to any worker on behalf of the absentee worker.
6. Payment of wages through banks, like ATM accounts of workers

Attendance and Time Recording

The cost of labor varies with time, especially for workers that are paid hourly or daily. In order to
control cost, an organization should establish a policy for reporting attendance and time. The
attendance record is used for calculating the salaries and wages of the employees to comply with Labor
laws. Time recording assists the organization in allocating the time to various jobs, activity or process or
overhead.
Time Recording

The following documents are used to monitor the recording of time to specific job, activity or process:

1. Clock Card or Time Card. Provides reliable evidence of the employee’s presence in the plant
from time of entry to departure.

2. Job Card or Job Ticket or Time ticket. This is used to record the time spent by the worker on
Each job.

3. Daily or Weekly Time Sheet. This is commonly used when a worker has a number of small
jobs during the normal working hours . The worker records the number of hours incurred
To each job on a daily basis or weekly basis.

The respective department supervisors should initiate the individual

Time card, time ticket or time sheet to ascertain the correctness of the time report.

MEASUREMENT OF LABOR EFFICIENCY AND PRODUCTIVITY

When productivity increases, business profits and the real earnings of workers also increase. Increased
productivity enables society to obtain more and better output from the resources available in the
economy. In recent years, productivity has generally been increasing resulting in more available goods
and services. Increased level of productivity can be achieved only by motivated workers who show
initiative and accept substantial responsibility.

Better management of human resources offers the prospect of increasing productivity and product
quality by enabling workers to participate more directly in the management of their work. Four
fundamental assumptions characterize better human resource management:
1. People who do the work are best qualified to improve it.
2. Decision making should take place at the lowest level possible.
3. Worker participation increases both job satisfaction and commitment to company objectives
4. There is a vast pool of ideas in the work force waiting to be tapped.

Work Study

Work study is a technique for the improvement of productivity usually expressed in quantitative terms.
In involves a systematic analysis of human work which consists of method, time, and motion study in
relation to the performance of a job or activity.

Method Study

Method Study involves the critical analysis and examination of the method of work performance. It
aims to develop more productive methods in order to improve the overall efficiency by getting rid of
unnecessary movement, avoid delays, and other forms of wastage. Once the improved method is
developed, it is implemented as a new standard practice and employees are trained to adopt and gain
familiarity with the new practice.
Time Study

Time study involves the analysis of the time required to perform a given task under normal working
conditions. It aims to establish a standard time to carry out the operation with consideration for delays
due to employee fatigue and other unavoidable delays. Time study requires the operation or task to be
broken down into different elements ; each element is examined to determine the standard time for the
task or operation. Time study has a number of advantages, they are:
1. It facilitates the calculation of cost of production;
2. It helps to implement an incentive wage-payment scheme;
3. It facilitates budgeting, manning and production scheduling;
4. It helps in the establishment of production quotas for hourly-rated workers; and
5. Standard labor cost can be easily established

Some disadvantages of time study are:

1. It cannot be used for non-repetitive jobs
2. Quality is sacrificed at the cost of quantity
3. Splitting up task into different elements is a complex process
4. It is not mathematically accurate
5. Subjective elements dominate the scheme

Motion Study

Motion Study has been defined as the study of body motions used in performing an operation, with the
thought of improving the operation by eliminating unnecessary motions and simplifying necessary
motions and then establishing the most favorable motion sequence for maximum efficiency.
Motion study has a number of advantages:
1. It enables the operations to be systematically planned;
2. It facilitates working in a faster and improved manner;
3. It leads to the increase in production and reduction in costs;
4. It helps in improving the arrangement of workplace, tools, implements, and plans, and
proper distribution of work among employees.
Some disadvantages of motion study are:
1. It creates frustration among workers and it may lead to strained relations between workers
and management;
2. It takes a lot of time to set right the motions to meet the desired expectations;
3. It is a costly exercise.

LABOR TURNOVER

Labor Turnover refers to the change in the labor force during a specified period. It represents the
proportion of the employees that leave through resignation, dismissal or attrition, to the number o
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 method calculates the number of separation as a percentage of the
number of employees during the same period

Labor Tunover = No. of Separation during the period x 100

Average no. of employees during the period

2. Replacement Method. This method calculates the number of new replacements as a

percentage of the number of employees during the same period. New recruitments for project
expansion are not included in thee total replacements.

Labor Turnover = No. of replacements during the period 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 of employees during thee period.

Labor Turnover = (No. of separation + No. of replacements) X 100

Ave. no. of employees during the period

Example: Assume the following workers on Payroll for 2019:

No. of employees, Jan. 1 2,600
No. of employees, Dec. 31 2,800
Employee resignations 50
Employee discharged 140
Employees recruited (of these, 60 workers were
Recruited for replacement of those who left
And the rest were recruited due to expansion
Plans) 450
The average number of employees during the year is2,700, which is calculated as: (2,600+2,800)/2. The
labor turnover ratio is then calculated as follows:

Method Calculation Labor Turnover Rate

Separation Method (50 + 140) x 100 7.04%
2,700
Replacement Method 60 x 100 2.22%
2,700
Flux Method (50+140+60) x 100 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 (e.g., marriage, relocation, or death), some are controllable by the
organizations.

Causes of labor turnover that are avoidable include:

- Dissatisfaction with job or inadequate remuneration
- Unsatisfactory working conditions and facilities
- Poor morale and low levels of motivation within the workplace
- Bad relationship with co-workers/superiors
- Lack of employee welfare activities
- Lack of incentive and promotion

Management should perform necessary remedial action in order to keep the labor turnover at relatively
low level. There are additional costs associated with high labor turnover such as:
1. Recruitment costs will be incurred to find for the best candidates
2. Additional training costs and supervision for new hires
3. Loss of know-how and customer goodwill
4. Lower production rate
5. Potential loss of sales
It should be noted, however, that certain levels of labor turnover also provide some benefits to the
organization such as:
1. New replacements are sometimes important to bring new ideas, skills, and enthusiasm to the
labor force.
2. Labor turnover can help reduce its workforce when there is a low utilization rate and a number
of redundant tasks.

Factory Payroll

Factory Payroll costs are divided into two categories:

1. Direct Labor – also known as touch labor, represents payroll costs traced directly to a
product, Job, Activity or Process. Direct labor costs include the wages of machinists or
assemblers and other workers who physically convert raw materials to finished goods, thus
the term touch.
2. Indirect Labor - consists of labor costs incurred for a variety of products or jobs or activities
related to the production process but not readily traceable to the individual products, jobs
or activities worked on during the period. Indirect labor costs include the salaries and wages
of factory production manager, department supervisors, fork-lift operators, janitors and
factory accountants who support all jobs worked on during the period.

For a service business like an Auditing Firm, the salaries of the auditors are considered direct labor cost
relative to the individual client engagements that they worked on, whereas the salary of the firm’s
managing partner would be indirect labor that should be allocated to all of the clients audited in
determining the total costs of servicing clients.
Payroll Function

The payroll function’s primary responsibility is to compute the employees’ salaries and wages. It
involves combining the daily wages, determining the total earnings, and computing deductions and
withholdings for each employee. Payroll is often a function within the accounting department, as
opposed to being a separate department. The Accounting Department must maintain current
information concerning regulatory requirements regarding wages and salaries as these are subject to
mandatory deductions like SSS, Philhealth, Pag-ibig and withholding taxes.

Many companies now outsource their payroll function to payroll preparation services like Ramco, ADP
Global; Payroll Solutions Phils., Manila Payroll Softwares, E-Sixty Corp, D&V Phils., K. Grace Consulting
Group and many more.

ACCOUNTING FOR LABOR COST

1. Direct Labor Cost is charged to the Work in Process Inventory Account

2. Indirect Labor Cost is charged to Factory Overhead Control
3. Idle Time – represents that portion of hours paid that are not utilized in the production. Idle
time results from the following situations:
a. Normal Idle Time
- Time lost in setting up machine, tools, change over from one job or another
- Stoppage of production due to machine breakdowns, materials shortage, and
power failure
b. Abnormal Idle Time
- Excessive machine breakdown
- Excessive Internal Power Failure
- Excessive Waiting time for materials, instructions, etc.
- Excessive time incurred to rectify defectives
- Labor strike, lockout, fire, flood, etc.

It is essential to segregate the idle time arising from the normal and abnormal situations for proper
planning and control. The following measures help control Idle time:

- Preparation and analysis of labor utilization report with breakdown of idle time
- Performing regular maintenance to minimize machine breakdowns
- Proper materials planning, that is, timing of purchase, safety stock , etc.
- Proper production planning

Labor costs relating to Normal Idle Time is charged to factory overhead

Labor costs relating to Abnormal Idle time is treated as a Period cost.

To illustrate: If the daily wage of a direct worker is P900 for 8 hours and idle time is normally 10% of
total hours, the direct labor cost is P125 per hour as calculated below:

Regular Rate = Direct Labor Rate Per Hour

Applicable work hours-Idle time
 P900 = P125 per hour
8 hours – 10% (or 7.2 hours)

Assume the following data:

Regular rate P100 per hour

Normal workweek 40 hours
Idle time due to normal machine breakdown 4 hours
If direct labor cost is not inflated as a result of normal idle time, the breakdown of labor cost is as
follows:
Direct labor (P100 x 6 hours) P3,600
Factory Overhead (P100 x 4 hours) 400
Labor cost for the week P4,000
======

OVERTIME

Overtime premium in general is treated as factory overhead, which will be recovered by way of
overhead absorption rates. 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. If overtime premium is paid due to abnormal
causes, it should be charged to profit or loss

Example: Assume the following data:

Regular Rate P100 per hour
Overtime Pay in excesd of 8 hours P150 per hour
Normal workweek 40 hour
Actual hours worked 46 hours
Idle time none
Overtime premiums charged to factory overhead control.

The breakdown of labor cost is as follows:

Direct Labor (P100 x 46 hours) P4,600
Factory Overhead Control (P50 x 6 hours) 300
Labor cost for the week P4,900
======
The following entry is recorded to distribute the payroll:

Work in Process Inventory 4,000

Factory Overhead Control 300
Payroll 4,300

Only the overtime premium is charged to factory overhead control 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 cost, the entry to distribute
the payroll is:

Work in Process Inventory 4,900

 Payroll 4,900

Charging the overtime premium to a specific job or product or to factory overhead primarily depends on
the reason for the overtime work. When a particular job is taken on a rush order with foreknowledge
that overtime will be necessary, the agreed price of the job presumably is set high enough to cover the
overtime premium; in such a case, the premium should be charged to the specific job. But when
overtime is used because the volume of regular orders simply cannot be completed in regular working
hours, then the overtime premium should be charged to factory overhead control, because it is not
caused by the work that happens to be done during overtime hours. This is because an essentially
random element in scheduling generally determines which job or jobs are scheduled to be worked on
during overtime, so the premium is not traceable to those jobs but rather to the high total volume of
work. If overtime is budgeted at the beginning of the year, its total budgeted cost is included in
calculating the predetermined overhead rate.

SHIFT PREMIUMS

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

BONUS, VACATION, AND HOLIDAY PAY

Employees may receive bonus pay for different reasons such as exceeding production or sales quotas, or
for achieving other performance targets that management feels merits additional pay. Vacation pay is
earned by the employees for their service on the job over the year. Holiday pay is based on the
agreement between the company and the employees in which certain holidays during the year will be
paid for by the company , but they are nonworking holidays for the employees.

Bonus Pay, Vacation Pay and holiday pay are gradually earned during the time the employee is on the
job and 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.

Illustration: Assume that a factory supervisor earns P2,900 per week (based on 5-day workweek) and is
entitled to a 10 paid holidays, two weeks vacation and P5,000 bonus. For each of the 50 weeks that the
supervisor works (52 weeks less 2 weeks of vacation), the factory overhead control account would be
debited for 332. If the supervisor is a sales worker or general office worker, selling or general expenses
would be:

Holiday Pay:

Salary per day (P2,900/5 days) P580

X number of paid holidays 10
Total Holiday Pay 5,800
 Divided by number of working weeks 50
Holiday pay expense per week P116
====
Vacation Pay:
Salary per week P2,900
X number of vacation weeks 2
Total vacation pay 5,800
Divided by number of working weeks 50
Vacation pay expense per week P 116
=====
Bonus:
Year-end bonus P5,000
Divided by number of working weeks 50
Bonus expense per week P 100
======

The following entry is made to record the weekly accrual:

Factory Overhead Control 332

Accrued Expenses 332

EMPLOYEE BENEFIT PLAN

An organization may provide different types of employees benefit plans or retirement benefits for all
qualified employees. The employer 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 a whole.

PAYROLL DEDUCTIONS AND CONTRIBUTIONS

The following are the common payroll deductions required by the government:
1. Withholding Tax on compensation. This is the tax withheld by the employer from the
employee’s taxable compensation income arising from an employer-employee relationship.
Compensation is based on graduated withholding tax rates ranging from 0% to 35% on net
taxable compensation.

2. Social Security system contribution. SSS is a Philipine social insurance program for workers in
the private, professional and informal sectors. It is aimed at providing benefits for members
and their beneficiaries such as pension, death, funeral, maternity leave, permanent disability,
retirement, sickness, and involuntary separation/unemployment. Both the employee and the
 employer contribute to the SSS equivalent to 11% of the monthly salary credit not exceeding
P16,000 and being shared by the employer (7.37%) and the employee (3.63%)

3. Philippine Health Insurance Corporation. Employed members need to pay a monthly

contribution equivalent to 2.75% of their monthly basic salary. The monthly premium is both
shared by both the employee and the employer. Philhealth members and beneficiaries have
accesss to a comprehensive package of services, including inpatient care, catastrophic coverage,
ambulatory surgeries,deliveries and outpatient treatment for certain illnesses.

4. Home Development Mutual Fund HDMF or (Pag-ibig Fund). It was established to improve the
quality of life of its members 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. Maximum contribution per month is P100 employee’s share and P100
employer’s share

5. Employee Compensation Commission (ECC). The Employees Compensation Program is a

government program designed to provide a compensation package to public and private
employees or their dependents in the event of work related sickness, injury, or death coverage.
Employer pays the monthly ECC premium as follows:

Range of Compensation ECC Premium paid by the Employer

P900 – P14,749 P10
P14,750 and above P30

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 functions or divisions.

2. Employee Deductions and Contributions. Employee deductions and contributions like

withholding tax, SSS, Philhealth, and HDMF should be credited to appropriate liability accounts,

3. Net Pay. The difference between Gross Payroll and all deductions and employees 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 Premium Payable XXX
Philhealth Premium Payable XXX
HDMF Premium Payable XXX
Accrued Salaries (Net) XXX

4. Distribution of Gross Pay. 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 cost is charged to Factory Overhead
Control. Sales Salaries are charged to Selling Expenses and Administrative salaries are charged
to Administrative Expenses.

The following is the journal entry to record the distribution of Payroll:

Debit Credit
Work in Process Inventory XXX
Factory Overhead Control XXXs
Selling Expenses XXX
Administrative Expenses XXX
Payroll XXX

5. Employer’s Payroll Contributions. Contributions of employer in SSS, EC, Philhealth, and HDMF
do not affect the net pay of the employees. These are additional costs of the employer, hence,
recorded as an operating expense, except to 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 .

The following is the journal entry to record the employer’s payroll contribution:

Debit Credit

Factory Overhead Control XXX

Selling Expenses XXX
Administrative Expenses XXX
SSS Premium Payable XXX
ECC Premium Payable XXX
Philhealth Premium Payable XXX
HDMF Premium Payable XXX

6. Payment of accrued payroll. The accrued payroll should be debited when actual payment is
made to the employees.

The following is the journal entry to record payment of accrued payroll:

Debit Credit

Accrued Payroll XXX

Cash XXX
7. Remittance of employee and employer contributions to the appropriate government agencies.
When the employer remits the contributions to the different agencies after the payroll period,
the liability account is debited with corresponding credit to cash.

The following is the journal entry to record the remittance of the employee and employer’s
contributions to the appropriate government agencies:

Debit Credit

SSS Premium Payable XXX

Philhealth Premium Payable XXX
ECC Premium Payable XXX
HDMF Premium Payable XXX
Withholding Taxes Payable XXX

Cash XXX
 QUESTIONS
1. Amaryllis Corporation provide the following information:
No. of employees at the bginning of the month 600
No. of employees at the end of the year 640
No. of employees resigned 40
No. of employees discharged 10
No. of employees replaced 20
Required: Calculate the labor turnover by applying three methods:
a. Separation Method
b. Replacement Method
c. Flux Method

2. Barberton Corp. determined P284,200 payroll for the week (5 days)

consisting of P240,000 earnedby 80 direct laborers and P44,200 earned by
20 indirect laborers. The total factory bonuses to be paid at year-end is
estimated at P980,000. All factory workers receive a three-week paid
vacation and 10 paid holidays.

Required: Prepare the journal entries to:

(a) Distribute the weekly payroll and to
(b) Accrue the bonus, vacation, and holiday pay.

3. Calathea Company incurred payroll for the week(5 days) of P100,000 which
consists of P70,000 earned by 20 production workers and P30,000 earned
by 10 sales workers. Calathea also estimated that annual bonus of
P432,000 will be paid at year end. All employees are entitled to 4-week
paid vacation and 10 paid holidays.
Required: Prepare the journal entries to:
(a) Distribute the weekly payroll and
(b) Accrue the bonus, vacation and holiday pay
 4. Lizzie Corporation is a local manufacturer that uses a job order costing.
Manufacturing Overhead is applied using a predetermined overhead rate
based on direct labor cost. The cost ledger shows the following information
for the month of August:

Work in Process, Aug. 1 250,000

Materials used during the month 120,000
Direct Labor Cost during the month 100,000
Factory Overhead applied 80,000
Goods manufactured 296,000

Lizzie had 3 outstanding jobs in ending work in process inventory that are
expected to be delivered next month:
Job no. 108 with direct materials of P35,000; Direct Labor P20,000
Job no. 109 with direct materials of P45,000; Direct Labor P25,000
Job no. 110 with applied overhead of P28,000

Determine the total labor cost charged to Job no. 110

5. For the second week in October 2020, Lily Company’s records show direct
labor, P180,000; indirect factory labor, P30,000; sales salaries, P42,000;
and administrative office salaries, P15,000. Assume the withholding tax
rate is 20%.
Required:
(1) Prepare the entry to record the payroll liability.
(2) Prepare the entry to distribute payroll cost.
(3) Prepare the entry to record the employer’s payroll taxes in one compound
entry.