Labour Costing

Labour: Labour is a human resources and effort to convert materials

into finished goods.
Labour can be divided as direct labour and indirect labour.
Direct Labour: Direct labour is that labour which is directly engaged in
the production of goods or services and which can be conveniently
allocated to the job, process or unit. According to ICMA,
“Direct Labour cost is that cost which can be identified with and
allocated to cost centres or cost units.” For example, labour engaged in
making the bricks, carpenter for making furniture etc.
Feature of direct labour:
1. Direct labour is a part of prime cost;
2. It can be attributed to finished goods;
3. Its cost can be identified with total cost of production;
4. It varies with change in output;
5. It can be controlled.
Indirect Labour: Indirect labour is that labour which is not directly
engaged in the production of goods and services but which indirectly
helps the direct labour engaged in production. ICMA defines indirect
labour cost as “cost other than direct wages cost. For example,
mechanics, supervisors, chowkidars, watchmen, sweepers, foremen etc.
Features of indirect labour:
1. It is as importance as direct labour;
2. Its cost cannot be allocated but can only be apportioned;
3. It cannot be identified with the finished product;
4. It does not vary with the change in production;
5. It cannot be controlled;
Its cost is treated as overheads.
Differences between direct labour and indirect labour:
Labour Cost:
Labour cost is a second major element of cost. Research has shown that
in majority cases labour cost constitute about 40% to 50% of total cost of
production. It includes monetary benefits like basic wage, DA; deferred
monetary benefits like pension, gratuity; non-monetary benefits ( fringe
benefits) like canteen, housing; etc.
Components/ elements of Labour Cost:
Labour costs represent the various items of expenditure incurred on
workers by the employer and would include the following:
Control of Labour costs:
Control of labour cost is not as easy as that materials cost. The human
element in labour makes difficult the control of labour. Labour Laws in
India are such that one can’t dispense with the labour even if not need it
for some reason. Moreover, it is a perishable commodity and can’t
be store like materials. Labour, once lost, cannot be recouped and is
bound to increase the cost of production.The main aim of the control over
cost is to keep labour cost per unit of out as low as possible. Labour costs
can be controlled by proper employment and there afterwards efficient
utilization of labour force. Inefficiency of labour is also a cause of
excessive materials and overhead costs. There are a number of
departments in big industries which influence labour cost.
The coordinated efforts of all such departments will be needed to control
labour cost.
These departments are:
1. Personnel Department,
2. Engineering Department,
3. Time & Motion study Department,
4. Time Keeping Department,
5. Payroll Department &
6. Cost Accounting Department.
1. Personnel Department: Personnel department is concerned with
employment, transfer and discharge of employees. The department is
headed by a responsible officer called Personnel Manager. The important
duties of this department include recruitment, selection, training,
placement, fixation of remuneration, performance appraisal. Different
departments send their requisitions for placement of workers to personnel
department and the department decides on the
selection procedure to be followed. The department also keeps records of
particulars of employees. The record is kept on a card known as
Employee History Card.
Functions of this department are as follows:
(i) Recruitment and selection of workers.
(ii) Training and development of workers.
(iii) Orientation and placement of workers.
(iv) Maintenance of personnel records.
Time Study: It may be defined as the observing time required to do a
particular. It relates to fixing the standard time for doing a job under given
condition. It is a means to achieve economy in time.
Motion Study: It is the study of the movement of an operator or a
machine. It aims at eliminating unnecessary, ill-directed and inefficient
motions of an employee or machine.
Labour Turnover:
The change in the labour force is known as labour turnover. Thus,
labour turnover refers to mobility of employees from factory to factory
for getting better opportunities in terms of earning and position. It
denoted the percentage changes in the labour force of an organisation.
Normal labour turnover is advantageous as it allows injection of fresh
blood into the firm. But excessive turnover is not desirable because it
increases cost of labour. This is because efficient and experienced
workers leave the factory and new employees come and occupy their
places. Naturally, the ability of such new workers is less as compared to
that of the experienced workers. The desirable percentage of labour
turnover is placed between 3 percent and 5 percent.
Methods of measurement of Labour turnover:
Sometimes, flux rate can be calculated in the following way, when there
is recruitment for
expansion:

Where,
No. of Accession = No. of replacement + No. of new employment for
expansion.
SPECIAL ITEMS IN LABOUR COST CONTROL:
1. IDLE TIME:
Idle time is that time for which payment made but no direct production/
benefit is obtained by the employer. Hence, there is no production during
idle time. The question of the idle time arises only when the payment is
made on time basis. The difference between time booked and factory gate
time is known as idle time. Therefore is calculated in the following way:
Idle Time= Time keeping as per Time Card – Time booking as per Job
Card.
Idle time is of two types:
(a) Normal Idle Time: Normal idle time is that time the wastage of
which cannot be avoided; therefore the employer will have to bear the
labour cost for this time.
Reasons for normal idle time:
(i) Time taken by the workers from the factory gate to reach the spot of
production.
(ii) Time leg between two consecutive works. (for finishing one &
starting the next.)
(iii) Breaks allowed during the working hours. Such as tea, lunch break.
(iv) Interruption of machineries.
(v) Waiting for job, work etc,
(b) Abnormal Idle Time: It is that time the wastage of which can be
avoided by taking proper
precautions. Reasons:
(i) Break down of machineries,
(ii) Power failure,
(iii) Shortage of materials,
(iv) Unnecessary waiting for instruction, materials, tools etc.
(v) Strikes & lock outs.
Causes of Idle Time:
(a) Production causes:
(v) Machine break down,
(vi) Power failures,
(vii) Waiting for work,
(viii) Waiting for tools,
(ix) Waiting for materials,
(x) Waiting for instruction.
(b) Administrative causes: ( due administrative decision):
(i) No reduction in labour force during depression,
(ii) Under utilization of capacity of plants.
(c) Economic causes:
(i) Seasonality of products,
(ii) Non-availability of materials,
(iii) Lack of demand,
(iv) Period of depression.
Accounting treatment of Idle Time Cost in Cost Accounts:
1. Cost of normal idle time which is uncontrollable is treated as Direct
Labour Cost for each job.
2. Cost of normal idle time which can be controlled is treated as
Production Overheads.
3. Cost of abnormal idle time is not treated as part of cost and hence
charged to Costing Profit and Loss Account.
Control of Idle Time Cost:To exercise as effective control over idle
time , the following steps are suggested:
1. Step: Fix the standards for normal idle time such as tea break, lunch
break,
2. Step: Prepare Periodic Idle Time Report by showing reasons and cost
to the management.
3. Step: Compare the actual idle time with standard idle time to find out
the variance.
4. Step: Investigate the variance.
5. Step: Take the necessary corrective action promptly.
2. OVERTIME:
Overtime is an extra time over and above the normal working hours.
According to the Factories Act, 1949, a worker is entitled to overtime
wages when he works for more than 9 hours on a day and more than 48
hours in a week. In India, overtime is to be paid at double the normal
rate of wages. The additional amount paid on account of overtime is
known as overtime premium.
Overtime premium = Overtime Hours x Overtime Wage Rate.
Effects of Overtime premium on productivity:
There are adverse effects of overtime on the productivity of the worker
and on the cost of the production due to the following reasons:
(i) Overtime is paid at a higher/double rate;
(ii) Efficiency of the workers reduced in overtime work comparing to
normal time;
(iii) Worker will adopt the habit of postponing the work to be done in
overtime just to earn more wages, hence, fall in output during normal
time;
(iv) Regular overtime working has an adverse effect on the health of
workers;
(v) Expenses like lighting, cost of supervision, wear and tear on
machinery etc. will increase disproportionately;
(vi) It may lead to discontent (dissatisfaction) among workers if
overtime is not distributed properly.Therefore, overtime work should be
avoided because jobs done in overtime cost more compared to the job
done during normal hours. However, overtime cannot be totally
eliminated because there are some genuine reasons when there is no
other alternative but to do overtime work.
Control over Overtime Work:
Keeping in view the disadvantages of overtime work, it is necessary
that proper control should be exercised in order to keep it minimum
possible level. The following steps are to be taken in this regard:
1. A proper control should be exercised during normal hours to ensured
that overtime is not allowed when normal output is not achieved during
normal working hours.
2. A statement of overtime should be prepared by showing why, where
and how much overtime is required.
3. Fix an upper limit of overtime for each category of workers.
4. Do not allow any overtime without prior sanction from competent
authorities.
5. Compare the actual rate of output produced during the overtime
period with the normal rate of output.
6. Periodical report on overtime along with wagesheet should submit to
the top management.
3. LEAVE WITH PAY:
Leave days with pay constitute unproductive working days. According
to the Factories Act, workers are entitled to annual leave with full pay
for specified number of days in a year. This may include casual leave,
medical leave, special leave, etc. The cost of paid leave cannot be
charged to any work order or cot unit, since no work is done during this
period. It is, therefore, treated as indirect labour cost and charged to
overheads.
Alternatively, leave wages may be treated as direct labour cost when the
wage rate is inflated (overstated). This is done by estimating in advance
the amount of leave wages and spreading it over the actual number of
working hours to give it an inflated hourly rate.
4. ABSENTEEISM:
METHODS OF WAGES PAYMENTS:
The two principal methods of wages payments are as follows:
1. Time Rate Wage System, and
2. Piece Rate Wage System.
1. Time Rate Wage System: Under this system wages are paid on the
basis of time worked by the workers. There are different type of time
rate wage system, few of them are:
(i) Flat time rate: It is the oldest methods of wage payment. Under this
system, workers are paidat a flat rate on the basis of time they are
worked.
Earning/ wages = Actual time worked x Time rate
(ii) High day rate: Higher rate is given to attract the efficient workers
who can easily be motivated to achieve predetermined standards of
efficiency which is relatively high.
(iii) Graduated time rate: Under this method wages are based on cost of
living index of the workers.
Advantages of Time Rate Wage System:
1. It is easy to understand and simple to operate.
2. It provides guaranteed time wages to workers.
3. Worker can concentrate on the quality rather than the quantity.
4. There is less damage and wages of materials and tools.
Disadvantages of Time Rate Wage System:
1. It does not act as an incentive to workers.
2. It tends to increase overheads and labour cost due low production.
3. There develops a tendency to go slow during normal working hours
in the hope of
getting more wages by overtime.
4. High degree of supervision is required.
2. Piece Rate Wage System: Under this system wages are paid on the
basis of the number of
articles produced by the workers. Piece rate system can be of the
following types:
(i) Straight piece rate: Under this system, each unit produced is taken as
a piece. A piece rate is fixed for a unit of product produced. It can be
calculated in the following way:
Earning = No. of piece produced x Piece rate.
(ii) Piece rate with guaranteed wages: Piece rate with guaranteed wages
is applicable for the new and in efficient workers. They earn meagre
salary instead of paying normal piece rate and this
encourages the workers to improve their efficiency gradually and there
afterwards reach the standard of other workers.
(iii) Differential piece rate system: Under this system, the wages of
workers vary at different stages, within a certain range of output. The
two system which work under this principle are:
(a) Taylor’s differential piece rate system, and
(b) Merrick’s differential piece rate system.
(a) Taylor’s differential piece rate system: This system was designed by
F.W. Taylor in 1880. The features of this system of wage payment are
as follows:
(i) There is no guaranteed wages.
(ii) Standard time is fixed for each work.
(iii) Two differential piece rates are fixed: ‘Lower piece rate’ i.e. 80%
of the normal piece rate for the workers produce below the standard out.
‘Higher piece rate’ i.e. 120% of the normal piece rate for the workers
produce standard output or more than standard output.( Some authors
use 83% and 125% for lower and higher piece rate respectively.)
(b) Merrick’s differential piece rate system: This method is also known
as ‘Multiple piece arte system’. Under this method, three grade piece
rates are used instead of two as in the case of Taylor’s. The features are
as follows:
(i) There is no guaranteed wages.
(ii) Standard time is fixed for each work.
(iii) Slabs are:
Upto 83 1/3 % of the standard output- 100% of ordinary piece rate.
Above 83 1/3 % and upto 100% of the standard output -110% of
ordinary piece rate.Above 100% of the standard output- 120% of
ordinary piece rate.
Advantages of piece rate wage system:
1. It is easy to understand and simple to operate.
2. It acts as an incentive to workers to produce more to earn more.
3. It tends to reduce overhead cost and labour cost per unit.
4. It eliminates the tendency of workers to go slow as remuneration is
directly linked with performance.
5. Low degree of supervision is required.
Disadvantages of piece rate wage system:
1. It does not guarantee time wage to workers and hence workers feel
insecure.
2. Workers tend to increase the quantity ignoring the quality of the
products.
3. There may excessive wastage and damage of materials and machine,
tools.
4. The calculation of piece rate is more difficult than time rate .
5. It is usually opposed by trade union and workers.
7. It should provide for prompt payment of incentives at short intervals
of time.
8. It should have approval of workers and trade union.
9. It should discourage the workers to increase spoiled work.
10. It should be flexible enough so as to introduce the necessary
changes, if any required.
IMPORTANT TYPES OF INCENTIVE SYSTEM:
1. Halsey Premium Plan: This system was introduced by F.A. Halsey,
an engineer of America in 1891. The main features of this system are as
follows:
(i) Standard time is fixed for each work.
(ii) It guarantees the hourly wages to workers for the actual time taken.
(iii) Bonus is paid if the time is saved.
(iv) Bonus is equal to 50% of the time wages of time saved.
2. Rowan Plan: This incentive system was introduced by James Rowan
of Scotland. Under this system bonus is also paid on the time saved.