LABOR:Direct Labor Cost, Mechanical Methods, MAKING PAYMENTS TO EMPLOYEES

<< ACCOUNTING FOR LOSSES:Spoiled output, Accounting treatment, Inventory Turnover Ratio

PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans >>

Cost & Management Accounting (MGT-402)

LESSON# 11

LABOR

There are three elements of cost:

Material

Labor

FOH

Labor costs constitute an important part of production cost. Labor cost is and element of total

payroll expense of an entity. Payroll expense consists of:

Labor cost

Administrative staff expenses

Selling and distribution staff expenses

The total labor cost incurred by a manufacturing entity includes four separate elements:

Direct labor cost (this is expensed on production and it is traceable in the cost unit)

Indirect labor cost (this is also expensed on production but it is not traceable in the cost

unit)

Abnormal labor cost (this is the labor cost that is lost because of break-down of power and

machinery etc.)

Labor related cost (this includes overtime pay, bonus pay, shift allowances, and other

benefits)

From the cost and management accounting point of view, the distinction between direct labor

cost and indirect labor cost is very essential.

Direct Labor Cost

Direct labor cost is that portion of salaries and wages which can, as a practical matter, e traced

with and charged to a cost unit. Thus the wages paid to employees/workers engaged in

manufacturing of a job or process like bricks, spinning and weaving, are direct labor cost.

Broadly speaking, labor costs will be direct if:

There is a direct relationship to the product through a process,

The labor cost can be measured in the light of this relationship, and

The labor cost is sufficiently material (significant) in amount.

However, the main criterion of determining the direct labor cost is that if it is economically and

conveniently be identified /traced with a product, it is a direct labor cost.

Indirect Labor Cost

These are the costs which are not identifiable with or incurred directly in the production of a

specific goods or services but are applicable to manufacturing activities generally, salaries and

wages paid to supervisors, foremen, storekeepers, clerical staff member will constitute the

indirect labor costs. Mostly costs of service departments, supervisory and engineering

departments are indirect labor costs.

Salaries & Wages

Salary is a fixed amount of remuneration paid to the employees after a month or a year.

Wage is remuneration of the employees/workers who work on hourly or unit produced basis.

Determining Wage Rates

Wage rates are determined on the basis of requirements of a job. Job analysis is breaking up of a

job into basic elements or operations and studying them in detail to find out the duties,

responsibilities and skills involved in it.

Cost & Management Accounting (MGT-402)

It is a process of determining the contents and characteristics of a job, the conditions under

which performance is to be carried on, the qualifications required in the worker, methods and

techniques used and other conditions and skills involved. This basic object of job analysis is to

ascertain the relative worth of each job through an objective evaluation so that suitable

remuneration can be fixed for each Job and worker.

Advantages of Job Analysis

Job analysis facilitates selection of right type of workers according to the job

requirements. It helps in training the workers accordingly.

Job analysis helps in fixing suitable wage rates for different jobs according to their

characteristics, skills required and hazards involved.

It helps in Job evaluation and merit rating thereby improving the decision making

ability of the supervisory staff in regard to transfer, promotion and placement.

Job analysis facilitates the settlement of disputes with workers in regard to duties-

wages, transfer and other disciplinary action by providing complete requirements of different

jobs.

It helps in placing employees on the most suited jobs and thus increasing their

satisfaction and morale. It helps in reducing labor turnover, absenteeism and removes inequ-

alities in wages and salaries.

Time-Keeping

In an industrial enterprise accurate time keeping is very essential, normally, recording of time is

done for two purposes:

For administrative and payroll purposes, and

For cost analysis and apportionment of overhead among different departments.

Wages to casual and temporary workers are paid on time basis while others are paid on piece

rates with minimum guaranteed wages. Payment of wages to such categories of workers is

dependent on the proper recording of total time spent by a worker in the factory and on the Job.

Purposes of Time-Keeping

Recording of time is essential for the following purposes:

Preparation of Pay Rolls, where the workers are paid on time basis.

.Meeting the statutory requirements.

For internal administration, like increments, pension, provident fund, gratuity and leave

benefits.

For proper distinction between direct and indirect costs, normal time and overtime,

and regular and late comers.

For overhead rates, if based on labor hours.

For enforcing regularity, discipline and ensuring daily requirement of labor force in the

factory.

Methods of Time-keeping or Recording:

Following are the usual methods of recording attendance of workers at the gate of a factory.

1)Manual Methods:

A. Attendance Register, and

B. Token system

2) Mechanical Methods:

A. Time recording clock, and

B. Dial Time Recorders

3) Electronic Methods:

A. Smart card

Cost & Management Accounting (MGT-402)

Manual Methods

Attendance Register method (Hand written record):

Under the method a register with necessary columns like name, identity no. of the employee and

arrival and departure time is maintained.

In a large factory, separate registers may be maintained for each department but in a small

factory one register may serve the needs of the entire factory.

The practice of recording attendance or roll calls may conveniently be adopted depending upon

the nature of employees and their number. As soon as a worker enters into the premises of the

factory the necessary entries in the attendance register are completed either by calling the name

of each worker or by some other physical method.

Disk or Token or Check method:

Under this method each worker is allotted a metal disk or token bearing his identification. On

each disk the name and number of the worker is engraved or painted. All the tokens or disks are

hung on a board serially note the arrival time of the workers.

As soon as a worker reports for duty on the appointed time he/she removes his/her disk from

the board and puts into a box. Immediately after the scheduled time for entering into the

premises of the factory the board is removed and a list is prepared of all such disks or tokens not

collected and dropped into the box by the workers. The late comers collect their disks and hand

over personally to the time keeper. The list of late comers is prepared separately. The tokens not

removed from the boards represent the absentee workers.

Mechanical Methods

Different mechanical devices have been designed for recording the exact time of the workers.

These include:

a. Clock Card

b.Dial Time Records.

Clock Card

The attendance of workers in this system is marked by a time recording clock on a card each

worker is given a clock card usually for one week duration. These clock cards are serially arranged

and kept in a tray at the gate of the factory and as the worker enters into the gate he picks up

his/her clock card from the tray, puts it in the time recording clock that records the exact arrival

time at the space provided on the card against the particular day.

This process is repeated where the worker leaves the factory after his/her day's work. Other

particulars of time in respect of lunch, late arrivals, early leaving and overtime are printed in red

so as to distinguish these from normal period spent in the factory. This is very popular method

of recording the attendance of workers. The format of clock card is given below:

Cost & Management Accounting (MGT-402)

FUTURE SHINE CO. LTD

Clock Card

Worker's Name____________ Department ___________ Token # ___________

Week______________

Days

Time

Regular-time

Over-time

Total-time

Out

Normal

Over-

time

Monday

A.M.

P.M.

Tuesday

A.M.

P.M.

Wednesday

A.M.

P.M.

Thursday

A.M.

P.M.

Friday

A.M.

P.M.

Saturday

A.M.

P.M.

Sunday

A.M.

P.M.

Calculations of

Normal

Over-

Rate

Amount

Deductions

Net

Hours

payable

Worked

Time keeper____________ Foreman_______________ Payroll Clerk ______________

Worker____________

Cost & Management Accounting (MGT-402)

Electronic Methods

In the era of Information Technology wastage of time is considered as a sin. Although manual

and mechanical methods produce accurate results but both are time consuming methods. Same

results with less time consumption and lesser chance of errors can be obtained with the

application of electronic devices. Now a days clock cards have been substituted with the smart

cards.

Smart Card

Clock cards may be replaced by smart cards. These record the same information, but it is

recorded on the magnetic strip on the card. Smart cards may also be used for other purposes not

related to the payroll.

Job Time Sheets

For proper labor cost analysis, it is essential that the worker records, in details, his/her activities

of production and time he/she spends on each job correctly. Time spent by a worker on the job,

process or activity may be recorded manually, mechanically or electronically depending upon the

nature and size of the enterprise. Recording of time spent by the worker on the job is better

known as time booking. The objects of time booking are:

To ensure that the time paid for is properly utilized.

To ascertain the labor cost for each individual job and the cost of work done

To determine the rate of absorption of overhead expenses based on direct labor and

machine hour methods against each job.

To ascertain and minimize idle time.

To evaluate each employee's performance by comparing the actual time taken with the

budgeted time.

For achieving these objectives it is very important that clear instructions should be issued and

proper forms are designed for recording work time.

Cost & Management Accounting (MGT-402)

FUTURE SHINE CO. LTD.

Daily Time Sheet

Worker's Name____________ Department ___________ Token # ___________

Date______________

Job or

Work

Descriptio

Time

Total Hours

Cost

work

done

n of work

order.

Off

Ordin

Overti

Rate

Amount

Total hours_____________

Workers______________

Total cost_______________

Fore man____________

PAYROLL SYSTEM

The payroll is a list of the employees of the organization and the money due to each. A payroll

list is produced each time that employees are paid.

· Wage earners are paid weekly.

· Salary earners are paid monthly.

Sometimes, employees earn a fixed amount every week or every month. Sometimes there are

variations in the amount employees earn, due to overtime payments or bonuses or commissions

which add to their pay.

GROSS PAY AND NET PAY

DEDUCTIONS

The total amount earned in a week or month by an employee is called his or her gross pay.

This is not the amount of money that the employee receives, because deductions are taken away

from the gross pay, and the employee receives just the gross pay less deductions. This is known

as the employee's net pay.

The deductions from pay are usually a combination of:

· Statutory deductions and

· Non-statutory or voluntary deductions.

Statutory deductions are deductions from pay that are made by law. In the Pakistan income tax

is taken away from gross pay and paid to Income Tax Department, which is the main tax-

collecting department of the government.

Cost & Management Accounting (MGT-402)

Income tax is collected from employees every time they are paid, and this system of tax

payment is therefore known as Pay As You Earn or PAYE. An employer is required by law to

deduct income tax from the wages and salaries of all their employees.

The employer in effect acts as an unpaid tax collection agent for Income Tax Department.

Non-statutory deductions are voluntary deductions from pay that the employee chooses

to make. Examples of these are:

· Subscriptions to a trade union

· Contributions by the employee to a pension scheme.

Rupees

Gross pay

***

Less:

Statutory deductions

(***)

Non-statutory deductions

(***)

Net pay or take home" pay

***

What this means is that when an employee is paid, he or she receives the net pay or take home

pay, and the employer pays the other amounts to other organisations ('external agencies') such as

Income Tax Department, a trade union and a pension scheme organisation.

COST OF LABOR TO THE EMPLOYER

Although the employee only receives the net pay, all the deductions have to be paid to other

organisations, and it is the employer who has to pay them. Therefore, you might think that the

total cost of wages and salaries to the employer is the total of gross wages. In fact the total cost

of wages and salaries to an employer is higher than the total gross wages and salaries. This is

because there are two elements in Provident Fund Contributions.

There are employees' provident fund contributions. These are a part of the statutory

deductions from gross pay,

There are also employer's provident fund contributions. These are additional payments that

the employer has to pay the government.

The amount payable is related to the amount earned by the employees, but it is nevertheless an

additional labor cost for the employer.

To an employer, the total cost of wages and salaries is therefore:

Gross wages and salaries, plus

Employer's provident fund contributions.

OTHER DEDUCTIONS

The employer and employee may agree that other deductions should be made from the

employee's salary. Examples are:

(a) Pension contributions.

(b) Deductions under the payroll giving scheme (charity giving).

(d) Trade Union subscriptions.

(e) Deductions under Holiday Pay schemes,

(f) Certain other voluntary deductions agreed by the employer (for example, fees for use of the

company sports club).

Cost & Management Accounting (MGT-402)

PRACTICE QUESTION

The following figures have been extracted from a trader's records in respect of wages and salaries

for July.

Rupees

(i) Wages and salaries (gross)

6,300

(ii) Income tax

1,600

(iii) Employees' pension contributions

600

(iv) Employer's pension contributions

700

What is the total amount the trader will have to pay for wages and salaries for July?

4,100

4,800

6,300

7,000

What is the net pay received by employees?

4,100

4,200

4,800

5,600

PROCESSING THE PAYROLL

To process the payroll, an employer must, for each employee:

Calculate the gross wage or salary for the period.

Calculate the income tax payable out of these earnings.

Calculate the employee's state benefit contributions that are deductible.

Calculate the employer's state benefit contributions. For all employees collectively,

the employer must:

Calculate any non-statutory deductions.

Prepare a payslip showing the gross pay, deductions and net pay.

Make the payment of net pay to the employee.

Make the payments of all the deductions from pay and the employer's state benefit

contributions to the appropriate other organisations.

Record the payroll costs in the accounting system.

PAYSLIPS

A payslip will accompany each payment of salary or wages to an employee. It shows how the

amount paid has been arrived at, how much income tax and state benefit contributions has been

deducted. The provision of a payslip detailing the income tax and provident deductions is

another responsibility of an employer as required by the national law. Other deductions will also

be shown on the payslip.

Getting a payslip means that even if the employee receives wages or salary payments directly into

his bank account, he is notified of the payment and how much it is by receiving the payslips,

Payslips might be distributed to employees at work, or posted to their home address.

A payslip must show details of:

Gross pay

Deductions (itemized separately)

Net pay (Net pay is sometimes called 'take home pay').

However, there isn't a standard layout for a payslip and so payslips of different employers can

look very different.

An example is shown below.

Cost & Management Accounting (MGT-402)

Silver Glass Manufacturers

PAYSLIP

Employee: Syed Imam Din

Employee #. 256

National Tax Number:

Social

Date: 08-10-

Tax period:

7296849-5

Security: Y

week 40

Pay For Week Ending:

Hou Rate

Amount Rs.

Year To Date

October 8th.

Rs.

Rs.

Basic Pay

40.0

7.50

300.00

Overtime

5.0

15.00

75.00

Shift Allowance

10.00

20.00

Gross Pay

395.00

Pension (Employer's pension

15.00

contribution Rs.25.00)

Trade union subscription

10.00

Total Pay

370.00

16,605.00

Income Tax

57.92

2.711.32

Provident Fund (Employer's Cont

30.85

Rs.36,71)

NET PAY

281.23

Content of the Payslip

A payslip must show certain items, by law. Compulsory items in the UK are:

The employer's name

The employee's name

The date

The total gross pay, showing the calculation where it comprises different elements

such as bonuses, overtime etc

The employee's pension contribution (if there is any)

Other deductions from, or adjustments to, pay. If a set amount is deducted each pay

day the breakdown need not be shown, provided the employee was given the details earlier

Total gross pay to date for PAYE purposes

Total tax paid to date in the current tax year and tax due this pay day

National Insurance contributions due this pay day

Net pay.

The payslip may also show additional information (and often does), such as:

the employee's Payroll Number

the employee's Social Security Number

the employee's National Tax Number

the total provident fund contributions paid by the employee in the tax year to date

the method of payment, such as `paid through cheque or cash etc.'

Cost & Management Accounting (MGT-402)

employer's provident fund contribution for the current period

employer's provident fund contribution for the tax year to date

MAKING PAYMENTS TO EMPLOYEES

Most employers will have a set day on which employees should be paid, and it is the payroll

department's responsibility to ensure that wages are paid on the correct due days.

Weekly paid employees will be paid at least once a week, normally on the same day each week.

Usually the pay day will be either Thursday or Friday.

Monthly paid employees will be paid once a month, and there will be a formula for determining

the pay day. For example, this may be:

the last day of the calendar month

the last Friday or Saturday of the calendar month

the same date each month, such as the 26th.

Employees may be paid their wages in several ways:

in cash (but this is now very uncommon)

by cheque

by bank transfer

through the Banks Automated Clearing System (BACS).

PRACTICE QUESTIONS

Which of the following does not appear on a payslip?

Gross weekly wage for the employee

Tax paid to date by the employee in the tax year

Deductions paid by the employee

Details of the employee's expected pension.

Which is the most convenient way for a large employer to pay salaries electronically?

BACS

Bank transfer

By cash

By cheque.

Elements of Gross Pay

The amount of pay to which an employee is entitled may be earned in a variety of different ways.

These include:

(A) Basic pay, such as:

a. wages paid according to the number of hours worked

b. Wages paid according to the output of the employee.

c. salaries, for salaried staff

(B) Other pay, such as:

a. overtime pay, for extra hours worked by the employee

b. shift pay, to compensate for unsocial hours.

a. bonuses paid under bonus schemes, based on productivity, or profitability

b. commission paid, normally based on sales.

Rupees

Cost & Management Accounting (MGT-402)

Basic Pay

****

+ Bonus

****

+Overtime payment

****

+Other allowance

****

Gross pay

****

-Statutory deduction

(***)

-Non Statutory deduction

(***)

Net Pay

****

Payroll Entries

Payroll Preparation

Payroll expenses

100

Deduction of income tax

Payroll Payable

Payroll Distribution

Work in process

FOH

Administrative expense

Selling expenses

Payroll expenses

100

Payment

Accrued payroll

Bank

Cost & Management Accounting (MGT-402)

PRACTICE QUESTION

Direct Labor

15,000

Indirect Labor

10,000

Sales Salaries

7,000

Administrative Salaries

8,000

Total

40,000

Deductions

Income tax

4,000

Group insurance

1,000

Required:

Pass journal entries to record Payroll expense and its payment

Solution

Payroll expense

40,000

Income tax (Payable)

4,000

Group insurance (Payable)

1,000

Payroll Payable

35,000

Payroll payable

35,000

Voucher payable

35,000

Voucher payable

35,000

Bank

35,000

Work in process

15,000

FOH

10,000

Selling expense

7,000

Administrative

8,000

Payroll expenses

40,000

Table of Contents: