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Labour Cost - Lecture Notes

Cost Accounting (Saurashtra University)

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Lesson - Labour Cost

Introduction:
Labour cost refers to cost incurred in relation to human resources of an enterprise.
Examples:
1. Wages paid to production workers
2. Salaries paid to Managers and staff
3. Cost of training staff members

Objective
Labour cost after material cost is another significant element of cost. How much
labour cost comprises in total cost of production depends on nature of industry. In a
service sector labour cost is the main element of total cost as compared to
manufacturing sector.
So objectives of studying labour cost are:
1. To maintain a reasonable level of labour cost as per industry standard.
2. To maintain such a remuneration system which motivates the labour to enhance
the production.

Types :
There are 2 types of labour cost which are as follows:
 Direct Labour cost: Labour cost that is specifically incurred for or can be readily
charged to a specific job, contract, work order or any other unit of cost. Example:
All wages of laborers directly engaged in production and wages paid to workers
engaged in construction site are direct wages.

 Indirect Labour cost: Indirect Labour cost is that which cannot be readily
identified with products or services but are generally incurred in carrying out
production activities. Example: Wages and salaries to employees in HR
department, Accounts department etc.

Time keeping & Time booking:

Time keeping:
Time keeping means "keeping a record of the total time spent by worker inside a
factory" For example if a worker enters the factory at 9.00 AM atjd Leaves by 6.00
PM, the total time spent by him is 9 hours inside the factory is ascertained from time
keeping records. Methods of time keeping are as follows:
1. Attendance register
2. Metal disc method
3. Time recording clock

Time booking:
Time booking means charging the total time spent on various jobs, day-by-day and
worker-by-worker. For example a worker spend 9 hours inside the factory, the total
time of 9 hours spent may be charged as 4 hours on job A, 3 hours on job B, 1 hour on
job C and 1 hour is idle time.

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Objective of time booking:

 To ascertain the labour time spent on the job and the idle labour hours.
 To ascertain labour cost 'of various jobs and products
 To compute and determine overhead rates.
 To evaluate the performance of labour comparing actual time booked with
standard time.

Idle Time – analysis and control: It is the time during which the worker is not
engaged in production but paid for even such time.
Idle Time=Total Time (as per time keeping record) Less Productive time (as per time
booking record).

Types of Idle Time:

 Normal idle time: - It is inherent in any job situation and thus it cannot be
eliminated or reduced.
For examples: Time taken by workers to reach the production department from the
main gate of factory, Time lost between the finish of one job and starting the next job,
tea break etc.

 Abnormal idle time: It is the idle time which arises on account of abnormal
causes. For example strikes, lockout, floods, major breakdown of machinery, fire
etc.
Accounting treatment of idle time:

 Normal idle Time: The cost of normal idle time should be transferred to factory
overheads for absorption.

 Abnormal idle time: The cost of abnormal idle time should be charged to
Costing profit and loss account.

Overtime-analysis and control:

Meaning of overtime:
Overtime represents the work done by employees in excess of normal working
hours. For e.g. if the normal working hour are 8 hours and an employee works for 10
hours, 2 hours will be overtime. Overtime= Actual Hours of work done - Normal
Hours of work. Under the Factories & Shop & Establishment Act, 1948 a worker is
eligible for overtime pay, if he works for more than 9 hours a day or more than 48
hours a week. Hence, payment of overtime consist of two elements, the normal wages
i.e. the usual amount, and the extra payment i.e. the premium.

Accounting treatment of overtime premium: The treatment of overtime

premium is as follows:

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Labour Turnover:
Meaning of labour turnover: Labour turnover of an organization is the rate of change
in its labour force during a specified period. The rate of change is compared with an
index which acts as thermometer to ascertain its reasonableness.

The suitable index of labour turnover may be (1) the standard of usual labour turnover
in the Industry or (2) the labour turnover for a past period.

Higher Labour Turnover New and Inexperienced Workers Higher Cost of Production
Lower Labour Turnover Old and Experienced Workers Lower Cost of Production
Cost associated with Labour Turnover:

Preventive Cost: These costs are cost incurred to keep labour turnover at a low rate,
such as cost of medical services, welfare schemes and pension schemes. If a company
incurs high preventive cost the rate of labour turnover is usually low.

Replacement Cost: These are cost which arise due to high labour turnover incurred
for recruitment of new workers in place of the workers who have left, such as cost of
recruitment, training, abnormal breakage, inefficient workers etc. The company will
incur high replacement costs if rate of labour turnover is high.

 Replacement Method
 Separation Method
 Flux Method
As per replacement method:

Labour Turnover = Number of Employees replaced during the year /Average number
of employees during the year x100

As per separation method:

Labour Turnover =Number of Employees separated during the year / Average number
of employees during the year x 100

As per Flux Method:

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Labour turnover = No of new Employees + Employees Separated / Average number

of employees during the year x100

Note: Average number of employees = Employees in beginning + Employees at end

2

Wage system:
Methods of wage payment: The two principal method of wage payment are as follows:
 Time rate wage system
 Price rate wage system
 Time rate wage system:

Under this system worker is paid a fixed rate per hour or per day or per
month for the time-devoted by him. The time rate may be fixed with reference to rate
prevailing in the industry for similar work. Rate paid under this system must not be
less than the minimum wages fixed under the Minimum wages Act or any other Act
for the time being in force.

Computation of Wages. Wages= Actual Time Devoted X Time Rate

Suitability:

1. Where the task cannot be readily measured, counted and inspected and thus there
is no standard unit of output.
2. Where the task is non repetitive or non-standardized in nature.
3. Where quality of work is more important than quantity.
4. Where there are learners and trainees whose output cannot be expected to reach
the minimum standard.

Piece Rate wage system: Under this method a worker is paid at a fixed rate per unit
produced or job completed. Time spent on job is not considered for calculating wages.

Computation of Wages: Wages= Number of units produced X Price per unit

Suitability:
 Where task can be readily measured, Inspected and counted.
 Where a work is standardized and repetitive in nature.
 Where the quantity of work is more important than quality.
 Where high degree of supervision is not required.

Incentive system:
Meaning:

Incentive may be defined as "the simulation of efforts and effectiveness by offering

monetary inducement and enhanced facilities". It may be provided individually to
every worker or collectively to a group of workers. The basis objective of incentive is

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to improve productivity and increase production so as to bring down the unit cost of
production. Classification: Incentive scheme may be classified as below:
 Differential piece rate
 Premium bonus scheme
 Group bonus plan

Name of scheme & Formula

Halsey Plan - Hours worked X Rate per hour + 50% X Time saved X Rate per hour
Note:

Time Saved=Standard Time for Actual Output- Actual Time

Standard Time for Actual Output=Output X Standard time allowed per piece

Halsey weir plan - Hours worked X Rate per hour + 33.33% X Time saved X Rate
per hour Note:

Time Saved=Standard Time for Actual Output- Actual Time

Standard Time for Actual Output=Output X Standard time allowed per piece

Rowan Plan

Hours Worked X Rate per Hour + Time taken x Rate per Hour X Time Standard time
saved

Note:
Time Saved=Standard Time for Actual Output- Actual Time

Standard Time for Actual Output=Output X Standard time allowed per piece

Casual workers in the nature of indirect labour are treated as Production Overheads.

Out Workers: Outworkers are those who work outside the factory premises and may
be put under following two categories:

 Workers are on the payroll of the factory: They are on the pay-roll of the
factory and they are at customer's premises to perform some specific duties such
as repair work, sanitary work etc.

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 Workers who are not on the payroll of the factory: They are not on the payroll
of the factory and material and specific tolls are supplied to them and they use
their own premises and deliver manufactured goods. They are usually paid on
piece wage rate system basis.

Mechanization of factory: With the change in times new & improved

machines are purchased/ acquired which leads to number of benefits and some extra
costs also.

Benefits:
1. Reduction in wastage of material & then reduction in material cost
2. Reduction in Labour/ employees and thus reduction in labour cost
3. Reduction in overheads such as power cost, maintenance cost, rent for space etc.
4. Increase in contribution due to higher production

Costs:
1. Increase in Bonus/incentives to remaining workers
2. Increase in overheads such as Depreciation, Rent of Machinery etc.

Formulas
Piece rate system of labour Calculation:-

In this Approach wages are paid according to Quantity produced by the workers.

However efficient workers should be given some incentives & therefore following Approaches
will be developed by Orthodox Cost Accountant...

1] Taylor Approach:-
Level of Efficiency - Remuneration
Less than 100% - 83% of Std Piece rate
>=100% - 175% of Std Piece rate

Note: - In the Institute Study Material it is given 125% which is not correct.

2] Merrick Approach:-
Level of Efficiency - Remuneration
Upto 831/3% OR 83.33% - Std Piece rate
Above 831/3% OR 83.33% but Upto 100% - 10% above Std Piece rate
Above 100% - 20% above Std Piece rate

Time rate System of Labour Calculation :-

In this Approach Remuneration is Calculated according to actual time worked by the
worker.

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 HALSEY'S 50% PREMIUM APPROACH : -

Std Time: - It means Time allowed OR Std taken for Actual Production.
Actual Time: - It means Actual time take for Actual Production OR Actual Hrs Worked by the
Worker.
Difference between Std time & Actual Time, It represent Time Saved.
1st Part of the Formula Indicates Normal Wages
2nd Part of the Formula Indicates Bonus Amt or Incentives

 Rowan Approach :-

Mixed Approach :-

It is Developed by Gantt Task, This Approach is combination of Time rate system & Piece rate
system.
Level of Efficiency Remuneration
< 100% Actual Hrs Work X Std Rate Per Hour
100% Actual Hrs Work X [ Std Rate Per Hour + 20%]
> 100% Actual Qty Produced X High Piece rate
OR
Actual Hrs Work X Std Rate per
Hour + 1/3High Piece rate is fixed by the management

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