Labour

DIRECT INDIRECT

LABOUR

Determine if the work described is direct or indirect labour

Classification
(direct or indirect)
Labour work

Plumber fitting bathrooms into new houses

Project manager overseeing the building projects

Bricklayers who build the houses

Marketing manager − advertising new house for sale

Carpenter making doors in new houses

Electrician fixing electrical cables in new houses

The architect who visits the site to check that plans are followed

Project manager’s secretary

Sewing machinist at a clothes manufacturer

Factory manager

A hairdresser that cuts hair at a salon

Office receptionist

A mechanic who fixes cars at a car workshop

A mechanic who fixes trucks at a logistics firm

The difference between direct and indirect labour depends
on the ORGANISATION. It is not always the case that a
type of labour will always be either direct or indirect across
all organisations.

The main thing to remember when deciding if labour costs are direct or indirect is whether the work
done was directly involved in producing the product or service.
When direct labour (produc on) workers receive holiday pay and sick pay, this is treated as an
indirect labour cost.
Another indirect labour cost is idle me. This is when employees are unable to work when it is not
their fault, but they are s ll paid. An example of when idle me might occur is when a machine breaks
down, and work cannot start un l it’s fixed.
Generally, the basic pay of direct workers is a direct cost, and all other costs of direct workers are
indirect costs. All costs of indirect workers are indirect costs. A bonus paid to direct workers is an
example of an indirect cost paid to direct workers.
Here are some direct worker costs that require further classifica on:

Labour cost Description Classified as

Time in which direct workers are paid, but no

Idle time work is being done. Indirect cost

The premium above the basic rate paid to

workers for hours beyond their regular (agreed)
General overtime
hours.
premium Indirect cost

Overtime spent by workers to fulfil a customer’s

specific request (for example, to complete a job
earlier)
In this case, the overtime rate includes the basic
Overtime worked for
rate and overtime premium.
customer request Direct cost
Overtime
It is usual for staff to be paid an addi onal amount of money when they work extra hours. This
addi onal payment is known as an over me premium. It is o en, but not always, above their normal
rate of pay.
OT PAYMENT = BASIC PAY + OT PREMIUM
Over me premiums are indirect labour costs.
EXAMPLE

Sarah earns $15 per hour for each hour she works in a café. Her standard shift is for 7 hours.
Sometimes Sarah’s boss needs extra help and asks Sarah to work longer than her shift, paying her
an additional 50% per hour for this.
Today, Sarah worked 9 hours.
Calculate her total pay, and classify it as direct and indirect costs.

Answer:

$ Classification
Basic pay 9 hours × $15 135 direct
overtime premium 2 hours × $15 × 50% 15 indirect
Total pay 150

Basic pay is the total hours worked mul plied by the basic rate
Sarah’s basic pay is 9 hours mul plied by $15, which is $135.
This would be classified as direct labour cost to the café

Overtime premium i
The extra $7.50 on over me hours Sarah earns is called the over me premium.
over me premium of $ 15 that Sarah made is an indirect labour cost to the café.

The main thing to remember when deciding if labour costs are direct or indirect is whether the work
done was directly involved in producing the product or service.
If the reason for the OT is the work load from the company
=> OT Premium= Indirect LC
If over me is requested specifically by a customer (to rush product delivery, etc.),
= > then the basic rate and over me premium
= Direct LC
EXAMPLE -1
The following information is available regarding direct workers of a company:

Hours worked Hourly rate ($)

Basic hours (including 50 hours of idle time) 900 7.50

Overtime 150 10.50

Calculate the amount to be classified as direct and indirect labour costs.

Answer:
Direct labour cost Indirect labour cost
$ per hour $ $ per hour $
900 basic hours:
850 active hours 7.50 6,375
50 idle time hours 7.50 375

150 overtime hours:

150 active hours 7.50 1,125
150 hours of overtime premium 3.00 450
Total 7,500 825
Observations:
 the active basic hours of direct workers are direct costs.
 Idle time of direct workers is an indirect cost.
 Basic pay earned from overtime hours is a direct cost.
 Overtime premium of direct workers s indirect cost.

EXAMPLE -2
Remont employs 15 workers in a factory at an hourly rate of $3.60. A working day is 9 hours, and
usually 20 working days in a month. The firm budgets 6 hours per unit.
During October, there were only 14 working days because of a hurricane. To compensate for lost
production, each worker worked 45 hours over weekends for an overtime premium of 50%. Actual
production for October was 430 units, 20 units fewer than budgeted.
Calculate the direct labour cost for October.

Direct Labour Costs $

15 workers × 14 days × 9 hours × $3.60 6,804

15 workers × 45 hours × $3.60 2,430

Total direct labour costs 9,234

OTP : 15 workers * 45hrs * $3.6 * 50% = $’1,215
EXAMPLE -3
A summary of Perky's factory payroll for October showed the following:

Basic hours 7,000

Hours of overtime 1,000

Hours of idle time 500

The idle time, which arose due to a power cut, increased the hours of overtime worked due to general
work pressures.

Basic pay is $15 per hour, and overtime is paid at a premium of .

Calculate the indirect labour cost for October.

The overtime premium and the cost of idle time are indirect labour costs.

Indirect labour costs $

Overtime premium (1,000 × 33 1/3% × $15) 5,000

Idle time (500 × $15) 7,500

Total indirect labour costs 12,500

Recording Labour Costs

Hours worked can be recorded by attendance records and timesheets. These are usually linked to the
computerised accounting system, which verifies the employee and automatically calculates the hours
worked.
 Timesheets − these are commonly used in many service industries. Solicitors and
accountants often use them because they charge for their work based on how long they
have spent on a client’s project.

 Job sheets − these are often known as task-related timesheets and are used to list the
time spent on one particular job by several employees. The total time spent on a job can be
determined and accounted for at the end of the job.
Recording Labour Costs in Accounts
The first step in accounting for labour costs is to record the gross pay, net pay and any deductions in
the wages control account.
Paying Wages
 Payment of net pay to employees
Dr Salaries control (expenses)
Cr Bank / Cash (net pay)
  Payment of employee deductions and employer contributions to external entities
Dr Salaries control (expenses)
Cr tax PAYE / employee benefits

Accounting for Labour Costs in Wages Control

 Accounting for costs of labour (including employer contributions)
Dr Work-in-progress / production overheads / employer contributions
Cr Salaries control

Labour costs are then accounted for using the same principles applied to direct and indirect
materials costs.
 Direct labour costs are debited to the work-in-progress account
 Indirect labour costs are debited to the production overhead control account
 Both direct and indirect labour costs are credited to the wages control account.

The Wages (Labour) Control Account

Wages Control Account
$ $
Bank X Work-in-progress X
Payment of net wages Direct labour costs
Payables (tax, National insurance, X
etc.)
Production overheads
Mandatory deductions and
contributions Indirect labour costs X
Statement of profit and loss X
Other labour costs (like employer contributions,
etc.)

remuneration methods
Remuneration methods are the different ways an
organisation can pay its employees for their work.

For example, an employee can be paid a constant

salary for a fixed period (per week, month or year)

Time-Based System
Payment is based on the hours an employee works.
If they work overtime, they are usually paid a higher rate.
 Salary: Organisations pay salaried employees an agreed amount per month
  Wages: Waged employees are paid based on an agreed hourly rate, depending on how
many hours they work

 Overtime premiums are paid to persuade workers to work longer hours than normal. An
overtime premium will be in addition to the standard pay rate.

Salary, wages and overtime are time-based remuneration systems: payment is based on the time
employee’s work.

Advantages Disadvantages

 In time-based systems, there is no

incentive for employees to be
 Time-based payment efficient
systems are simple to  Everyone is paid the same
administer regardless of performance
 One standard rate applies to  More supervision is needed because
all employees in the same employees are not as highly
role (which seems fairer to motivated as they are when working
employees) under an incentive scheme

Piece-work system
Payment is based on the number of products that an employee produces.

DIFFERENCIAL STRAIGHT

Straight piecework - employees are paid a set amount for each unit of product they produce.
Here if you either produce 20 or 100 you will only receive the payment for actually produced

Differen al piecework - employees are paid different rates per unit depending on how many units
they have produced. They may be rewarded with higher rates as their produc on level increases
above agreed targets
Here when the produced goods exceeded the targed then we may receive incen ves for the produc ons extras
Within a piecework system, employees may receive a guaranteed minimum wage despite the number of
units produced. This is known as piecework with a guaranteed minimum wage.

EXAMPLE
Furniture Co pays its employees using a differential piecework scheme that includes a guaranteed
wage.
Details of the scheme are:
$5 per unit for up to 20 units per day
$5.20 per unit for each unit between 21 and 25 per day
$5.50 per unit for units 26 and each further unit per day
There is a guaranteed wage of $90 per day.
Calculate three different employees' wages based on producing the following in a day using
the above information:
Rohan produced 17 units
Divya produced 22 units
Solomon produced 27 units.

ROHAN: 17 units * 5 = 85

DIVYA: 20 units * 5 = 100

2 units * 5.2 = 10.4
= 110.4
SOLOMON 20 units * 5 = 100
5 units * 5.2 = 26
2 units * 5.5 = 11
= 137.5

EXAMPLE
Sarah Kowalski carves wooden animals for a small company supplying the tourist market. In week
26, her production was as follows:

Product Standard time allowed/unit Units produced

Deer 2 hours 6

Mink 1.5 hours 5

Owls 1 hour 12

Eagles 2 hours 6
She is paid $6 per standard hour of production (irrespective of actual time worked).
Calculate Sarah's earnings for week 26

Incentive-based systems
Employees may be paid a bonus if they have reached targets set by their employers.
These can be either individual or group-based schemes.
Employees may be given incentives to produce output more quickly than expected.
They are usually rewarded with extra pay (a bonus).
These are also known as bonus schemes and may be for individuals or teams (groups).
Incentive schemes can be either
o output- or
o performance-based remuneration schemes.
They are designed to encourage employees to work harder or more efficiently.

Incentive type Description

payment is a fixed amount for each item (each piece of work)

completed, regardless of how long it takes.
This means that more efficient workers get paid more than
inefficient workers.
This method can guarantee the cost per unit for organisations, which
helps planning accuracy.
Piecework

a monetary incentive based on the performance of an individual, group,

or whole organisation.
Employees could receive a bonus based on their performance, or all
employees might receive a share of a group bonus.
Bonuses

Commissions are paid based on a successful outcome.

They are often used in sales as a percentage of the sales amount.
Commission

Profit-sharing Employees are given a share of the profit made by the organisation in
schemes the year.

Advantages Disadvantages

 Help to increase production while controlling  Incentive schemes are more

costs per unit, which helps the accuracy of expensive to administer
planning
  More efficient employees are paid more than  Quality control is needed to
inefficient or less hardworking employees ensure output meets
standards.
 May attract more skilled workers

Labour turnover
Labour turnover is the rate at which employees leave an organisation.
Employees may look for new jobs for various reasons:
 Offered a higher salary elsewhere
 Non-conducive work environment or inflexible working hours.
 Seeking a better social environment.
 looking for a new challenge or career advancement.
 Seeking a more secure position during a challenging economic period.
 Retirement or extended leave.

The Costs of Labour Turnover

Labour turnover creates costs for an organisation. The costs of labour turnover can be analysed as
follows:
 Preventative costs: the costs involved in preventing employees from leaving an
organisation
 Replacement costs: the costs involved in replacing those employees who have left an
organisation.
EXAMPLE
Classify the measures as preventive or replacement costs.
Preventive or
Measure Replacement

Pay competitive salaries and research to work out what figures are
competitive

Cost of training new staff

Provide employee benefits, for example, gym membership, staff

discounts

Offer employees training and development programmes

Cost of advertising for new staff

Cost of recruiting temporary staff to cover work when a position

becomes vacant and before new staff is appointed.

Cost of working hours lost while interviewing job applicants

Offer bonuses for increased productivity

Labour Turnover Rate

The labour turnover rate measures the number of employees leaving in a period and
expresses this as a percentage of the total labour force.
EXAMPLE
Magazine Co made a series of redundancies after a decrease in its business’ profits. It
had 25,000 employees at the beginning of 20X4 and 19,000 employees at the end of
20X4. As well as the redundancies, 2,000 employees resigned in the year and were
replaced by new employees.
What is the labour turnover rate in 20X4 to the nearest whole per cent?

Answer:

Average number of employees = (25,000 + 19,000)/2 = 22,000

Number of replacements = 2,000

Using the formula:

= 2,000/22,000 × 100% = 9% (to the nearest whole per cent)

Repacement = 45
Avg emp; (300 + 500) / 2
N
LTR = 45 / 400 = 11.25%

Answers LTR = 1500 / { (15000 + 11000) / 2}

= 11.54 %
a) 40 / {(300+500) / 2} = 11.25%
b) 1,500 / { (15,000 + 11,000) / 2} = 11.54%
 Labour ratios
There are several ratios that organisations use to measure the performance of their employees.

PLEASE MEMORISE THE FORMULA

Efficiency Ratio
The efficiency ratio measures whether the production output took more or less direct labour time than
expected.

A ratio of > 100% indicates greater labour efficiency than budgeted.

A ratio of < 100% indicates poorer labour efficiency than budgeted.

Capacity Utilisation Ratio

The capacity utilisation ratio measures whether the total direct labour hours worked were greater or
less than budgeted.

A ratio > 100% indicates more labour hours were worked than budgeted.
A ratio of < 100% indicates fewer labour hours were worked than budgeted.

Production Volume Ratio

The production volume ratio measures how the actual production output for a period (in direct labour
hours) compares with the budgeted output.

A ratio > 100% indicates higher than budgeted performance.

A ratio of < 100% indicates a lower-than-budgeted performance
Relationship Between Labour Ratios

EXAMPLE - 1
A company has 2,000 hours available (budgeted) to make 20,000 units of a product in
March. The company produced 18,000 units which took the workforce 1,750 hours.
Calculate the efficiency, capacity, and production volume ratios for March

EXAMPLE -2
Brownie Co budgeted to make 100 units of output in June. Each unit was expected to
take 3 hours of direct labour.
The actual production volume in June was 110 units, which took 350 hours of direct
labour.
For June,
 What is the labour efficiency ratio for Brownie Co?
 What is the capacity utilisation ratio for Brownie Co?
 What is the production volume ratio for Brownie Co?
 Show the relationship between the ratio

EXAMPLE -3
A company budgeted to make 800 units of output in December. Each unit was
expected to take 1 hour and 30 minutes of direct labour.
The actual production volume in December was 760 units, which took 950 hours of
direct labour.
For December,
 What is the labour efficiency ratio?
 What is the capacity utilisation ratio?
 What is the production volume ratio?
 Show the relationship between the above ratios.
s.