Chapter 4

Accounting For Labour

Learning Outcome 1: Analyze Direct and indirect costs of Labour
Direct labor and indirect labor costs are two categories of labor costs incurred by businesses.
Here's a breakdown of each:

1) Direct Labor Costs:

Direct labor costs refer to the wages and benefits paid to employees who are directly involved in
the production of goods or services. These are the costs directly attributable to the production
process. Direct labor costs typically include:
A) Wages or salaries of workers directly involved in manufacturing, assembling, or
providing services.
B) Overtime pays for workers directly involved in production.
Direct labor costs are considered variable costs because they vary with the level of production.
As production increases, so do direct labor costs. These costs are directly assignable to specific
units of production.

2) Indirect Labor Costs:

Indirect labor costs are the expenses associated with employees who are not directly involved in
the production process but are necessary for the overall functioning of the business. These costs
support the production process or the general operation of the business. Indirect labor costs may
include:
– Salaries or wages of maintenance staff, supervisors, quality control inspectors, and other
support personnel.
–Bonus payments.
– Benefit contributions.
– Idle time (when workers are paid but are not making any products, for example, when a
machine breaks down).
– Sick pay.
– Time spent by direct workers doing ‘indirect jobs’ for example, cleaning or repairing machines.
Note: Overtime premiums are usually classified as an indirect labour cost but if the extra hours
are at the specific request of a customer because they want a job to be finished as soon as
possible they can be classified as direct labour.

Test Your Understanding 1

Which one of the following should be classified as direct labour?
A Supervisors' salaries in a factory
B Maintenance workers looking after equipment in a hospital
C Bricklayers in a house building company
D Wages of cleaning and housekeeping personnel

Learning Outcome 2: Analyze Types of Remuneration Method

"Remuneration method" refers to the approach or system used by a business to compensate its
employees for their work. It encompasses the various ways in which employees are rewarded
financially for their contributions to the organization. Remuneration methods can include salary,
hourly wages, commissions, bonuses, profit-sharing, stock options, and various benefits and
perks. There are three basic remuneration method- Time related , piece work related and
Incentives Schemes.

1) Time Related Systems

The most common remuneration method is to calculate pay or wages based on
the number of hours an employee works.
- Employees are paid a basic rate per hour, day, week or month.

-Time-based systems do not on the whole provide any incentive for employees to
improve productivity and close supervision is often necessary.

-Overtime can be paid at a premium if any extra hours are worked.

- The formula for a time-based system is as follows.
Total wages = (total hours worked × basic rate of pay per hour) +
(overtime hours worked × overtime premium per hour)

Methods for recording the length of time an employee spends working can include:
 time sheets
 time cards
 job sheets.
 2) Output Related Systems

A piecework system pays a fixed amount per unit produced. The formula for a
piecework system is as follows.

Total wages = (units produced × rate of pay per unit)

- A guaranteed minimum wage is often required due to minimum wage requirements.
- Piecework is often combined with a time-based system to provide an added incentive to
employees.

Types of piecework system

There are two main piecework systems that you need to know about:

A) Straight piecework systems – the same rate per unit is paid no matter how many
units are produced. These systems are almost extinct today as employees are more
likely to be paid a guaranteed minimum wage within a straight piecework system.

B) Differential piecework systems – these systems are the most widely used piecework
systems and involve different piece rates for different levels of production.

Test Your Understanding 2 (Question related to Differential Piecework System)

Test Your Understanding 3 (Question related to Piecework combined with a guarantee Scheme)
A company operates a piecework system of remuneration, but also guarantees its employees 75%
of a time-based rate of pay which is based on $19 per hour for an eight-hour working day. Each
unit should take 3 minutes to produce (standard time). Employees are paid based on the number
of hours their output should have taken (standard hours). Piecework is paid at the rate of $18 per
standard hour. If an employee produces 200 units in eight hours on a particular day, what is the
employee gross pay for that day?
Gross Wages:

3) Incentive schemes
Incentive schemes, also known as incentive plans or incentive programs, are structured
strategies implemented by organizations to motivate employees to achieve specific goals
or objectives. These schemes typically offer rewards or bonuses to employees who meet
or exceed performance targets, thereby aligning individual efforts with organizational
goals. Incentive schemes can take various forms, including:

A) Bonus
Notes: In the examination you will be given clear instructions on any bonus scheme in operation.
You should follow the instructions given carefully in order to calculate the bonus payable from
the data supplied.
B) Measured day work
The concept of this approach is to pay a high time rate, but this rate is based on an
analysis of past performance. Initially, work measurement is used to calculate the allowed
time per unit. This allowed time is compared to the time actually taken in the past by the
employee, and if this is better than the allowed time an incentive is agreed.

C) Share of production
Share of production plans are based on acceptance by both management and labour
representatives of a constant share of value added for payroll. Thus, any gains in value
added – whether by improved production performance or cost savings – are shared by
employees in this ratio.

Test Your Understanding 4 (Question related to Incentive Scheme)

Which of the following methods of remuneration is not an incentive‐based scheme?
A Straight piecework
B Day rate
C Group bonus
D Differential piecework

Test Your Understanding 5 (Question related to Incentive Scheme)

Learning Outcome 3: Analyze Overtime and overtime premiums
If employees are entitled to extra pay when hours in excess of contracted hours are worked then
they will be paid for overtime. When employees work overtime, they receive an overtime
payment which includes a basic pay element and an overtime premium.
It is important that the overtime payment is analyzed correctly into direct and
indirect labour costs.
- Basic pay (whether it relates to overtime or normal working hours) is always classified as a
direct labour cost for direct labour workers.
- Overtime premiums are usually classified as an indirect labour cost but if the extra hours are at
the specific request of a customer because they want a job to be finished as soon as possible they
can be classified as direct labour.
- Employees who work night shifts, or other anti-social hours may be entitled to a shift
allowance or shift premium. Shift premiums are similar to overtime premiums where the extra
amount paid above the basic rate is treated as an indirect labour cost.

Test Your Understanding 6 (Question related to Overtime)

Learning Outcome 4 : Accounting For Labour Costs
Labour costs are recorded in an organisation’s statement of profit and loss. Accounting
transactions relating to labour are recorded in the labour account.
-Firstly, the labour account is debited with the labour costs incurred by an organisation. The total
labour costs are then analysed into direct and indirect labour costs.
-If the Labour costs if Direct Labour costs then Direct labour costs are credited from the labour
account and debited in the work-in-progress (WIP) account. Remember, direct labour is directly
involved in production and are therefore transferred to WIP before being transferred to finished
goods and then cost of sales.
-If the LAbour costs is Indirect Labour costs then Indirect labour costs are credited from the
labour account and debited to the production overheads account.

Test Your Understanding 7

How would the cost be recorded in the cost ledger if the direct labour costs in a manufacturing
company are $95,000?
A Debit Work‐in‐progress $95,000, Credit Wages and salaries $95,000
B Debit Wages and salaries $95,000, Credit Bank $95,000
C Debit Wages and salaries $95,000, Credit Work‐in‐progress $95,000
D Debit Bank $95,000, Credit Wages and salaries $95,000

Learning Outcome 5: Calculate Labour Turnover and analyse the costs and causes of
labour turnover.
Labour Turnover
Labour turnover is a measure of the proportion of people leaving relative to the average number
of people employed.
 Management might wish to monitor labour turnover, so that control measures might be
considered if the rate of turnover seems too high.
 Labour turnover is calculated for any given period of time using the following formula:
Test Your Understanding 8
A company had 4,000 staff at the beginning of 20X8. During the year, there was a major
restructuring of the company and 1,500 staff were made redundant and 400 staff left the
company to work for one of the company’s main competitors. 400 new staff joined the company
in the year to replace those who went to work for the competitor.
Required:
Calculate the labour turnover rate for 20X8.

Test Your Understanding 9

At 1 January a company employed 5,250 employees. Due to expansion the number of
employees increased to 5,680 by 31 December. During the year 360 staff left the company
and were replaced. What was the labour turnover rate?
A 6.3%
B 6.6%
C 6.9%
D 360 staff

Causes and costs of labour turnover

Causes
It is important to try to identify why people leave an organization and to distinguish between
avoidable and unavoidable causes of labour turnover.
Causes of labour turnover – avoidable:
– poor remuneration
– poor working conditions
– lack of training opportunities
– lack of promotion prospects
– bullying in the workplace.
Causes of labour turnover – unavoidable:
– retirement
– illness/death
– family reasons (e.g. pregnancy)
– relocation.
Efficient managers will investigate high levels of labour turnover and aim to keep that turnover
rate at a minimum.
Costs
Every time an employee leaves, an organization will incur costs that are associated with
replacing the employee. These costs are known as replacement costs.
Replacement costs include the following:
– advertising costs
– cost of selection (time spent interviewing etc.)
– training new employees
– reduced efficiency until the new employee reaches the required skill
A high labour turnover rate tends to lower the performance of employees who remain in the
organization. Such employees may become restless and resentful of the extra burden of training
new members and of additional temporary duties imposed upon them.
In order to keep the labour turnover rate to a minimum, organizations should aim to prevent
employees from leaving. Such preventive measures come with their own costs, known as
preventive costs.
Preventive costs include the costs associated with escaping the avoidable causes of labour
turnover:
– pay competitive wages and salaries if remuneration is poor
– improve poor working conditions
– offer good training opportunities
– make sure promotion prospects arise as necessary
– stamp out bullying in the workplace
– investigate high labour turnover rates objectively.
Learning Outcome 6: explain and calculate Idle time, labour efficiency, capacity and
production volume ratios.
1) Idle Time Ratio
Idle Time is the time for which the employee is being paid but during which they are not actually
working ( Eg because the machine had broker down )
Idle Time ratio = Idle Time/Total Hours *100
Note: A company should pay labour even in the idle time . (Total idle time * Basic rate). Idle
time payment is categorized as Indirect Labour costs.

2) Labour Efficieny Ratio:

This measures whether we are working faster or slower than expected.
Efficiency Ratio = Expected (or Standard) hours to make output/ Actual hour taken *100

3) Labour Capacity Ratio:

This measures whether we were able to obtain more or less working hours than we originally
budgeted on being available.
Capacity Ratio = Actual hours worked / Budgeted hours *100

4) Labour production volume ratio ( activity ratio ):

This measures whether we were able to produce more or less than we expected to produce based
on the budgeted hours available.
Production volume ratio = Expected (or standard) hours to make output/ Budgeted hours
*100

Test Your Understanding 10

A company budgets to make 800 units in 400 hours in a period. Actual output during the period
was 840 units which took 410 hours to make. Required Calculate the labour efficiency, capacity
and production volume ratios.