PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans

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Cost & Management Accounting (MGT-402)

LESSON # 12

PAYROLL AND INCENTIVES

Wages are paid to the workers as the reward of their labor and service. Different systems of

remuneration have been devised for meeting the requirements of both employees and employers.

Usually the employer makes a specified monetary payment to workers for a specified work or job

done. The specified monetary payment or minimum wages could either be related to a particular

hours of attendance or to the quantum of work.

Thus the wages are paid to the workers either for the time spent by them in an organisation or the

goods or services produced for it. So there are two basic systems of remunerating labor. One is

related to the time and the other relates to the quantum of work.

In between these two basic or extreme systems of labor remuneration there are a number of vari-

ants in vogue in many industries. Organized trade unions and state regulatory measures have

significantly contributed to the introduction of various bonus and incentive schemes for the labor.

Demand for increased wages is a natural consequence on the part of labor while the employer

tends to resist this demand. However, it must be borne in mind that high wages do not necessarily

results in higher cost of production.

If labor is satisfied with high wages it may ultimately lead to increased production and productivity.

The increased production and productivity will in return results in reduced labor and overhead cost

per unit. It is also essential requirement of a good wage system.

The aims of a wage system should be the introduction of a fair wage. A good wage system should

have, among others, the following features:

1. The system of wage payment should be fair to all workers

2. A guaranteed minimum wage should be assured to all workers.

3. The system should be acceptable to workers so as to avoid the work to rule, stoppage of

work and slow-downs.

4. It should have the elements of simplicity, certainty and flexibility.

5. It should provide adequate incentives to workers.

6. It should be in conformity of various labor laws and regulations both local and national.

7. It should invariably contain an increment clause providing for an automatic rise in wages

and attendances as cost of living index number increases.

8. The wage system should be simple and practicable so as to keep its operational and

administrative cost at a minimum.

Systems of Wages

Basically there are two principal systems of wages. They are:

(i) Time wage

(ii)Piece rate or Piece work

1. Time base wage

Under this system, wages to a worker are paid on time basis irrespective of the quantum of

production. The wage is measured on the basis of unit of time i.e. hourly, daily, weekly or monthly.

The formula is:

Hours worked x Rate per hour.

Assuming a worker is paid Rs. 110 per hour and he has spent 200 hours during a particular month

in a factory, his wages will be:

Rs. 22,000 i.e. (Time x Rate i.e. 200 x Rs.110).

2. Piece Rate wage

Under this method of remuneration a worker is paid on the basis of production and not time taken

by him to perform the work. This is one of the simplest and most commonly used of all incentive

Cost & Management Accounting (MGT-402)

schemes. The rate is expressed in terms of certain sum of money for every unit produced, e.g. Rs 2

per unit. The formula is:

Units produced x Rate per unit.

Suppose a worker is paid Re. 50 per unit and he has produced 20 units in 7 hours. His total wages

will be:

Rs. 1,000 i.e. (Units x Rate i.e. 20 x Rs.50)

However, a well regulated piece rate system has a guaranteed minimum wage. A well regulated

piece rate system, with a guaranteed minimum wage rate of compensation is much superior over

the time rate system.

Piece rate with guaranteed wage rate

Under this system a worker receives the straight piece rate for the number of pieces he produces,

provided that his total remuneration is more than his earnings on a time rate basis. If the piece rate

earnings fall below the minimum level of his earnings then he is paid on the time rate basis per

hour/per day).

Premium Plans

In between the two principal systems of remuneration described above, there are a variety of

bonus and premium plans of compensating workers for their extra efforts and skills. The basic

objectives of various bonus and premium plans are:

a. to induce the workers to increase the production and productivity,

b. to provide them additional wages for their skill and efforts,

c. to raise the morale of the labor high,

d. to reduce the cost of production,

e. to retain the services of good workers,

f. to induce the workers to serve the organisation with loyalty and sincerity, and

g. to establish better labor-management relations.

Essential futures of sound wage incentive plan:

Various incentive wage schemes have been designed to overcome the drawbacks of two principal

systems of labor compensation. A system of wage payment that would ensure both quality and

quantity of product is known as Incentive or Bonus or Premium plan. Essentially, all incentive

plans are a combination of the two basic wage plans, i.e., time rate and piece rate.

The following are some essential features of an incentive plan:

1. The plan should be acceptable to the workers, trade unions and management.

2. The incentive should be related to the efforts involved and should be sufficiently high

so as to provide inducement to greater effort.

3. It should be simple and should be understood by all workers easily.

4. The standard time or norms upon which wage incentive is based should be determined

on the basis of lime and motion studies.

5. Standards once fixed should not be changed unless it is necessitated by the change in

the method of work. Likewise unilateral and unwarranted rate cuttings should be

avoided.

6. No upper limit should be placed upon the amount of individual earnings.

7. The incentive plan should be aim at increasing production, reducing cost, and should

influence the workers morale.

8. The scheme should be operated without excessive and operative cost.

9. It should be consistent and incentive should be based on properly assessed lime values

of respective jobs.

Cost & Management Accounting (MGT-402)

10. The scheme should motivate the employees towards attainment of management

objectives by means of coordinated efforts of all concerned.

11. The grievances of the workers especially in respect of work standard and incentive

rates should be removed at once.

The success of an incentive plan largely depends on the mutual co-operation and understanding

between employer and employees and immediate removal of workers' grievances. And above all,

the payments of incentive or bonus should be made as soon as possible after the work is

completed.

Some Important Incentive Wage Plans:

Some of the important incentive wage plans are briefly discussed here with practical examples.

These are:

Time Rate Based Premium Plan

(1) Halsey Premium Plan.

(2) Halsey-Weir Premium System.

(3) Rowan Plan.

Piece Rate Based Premium Plan

(4) Taylor's Differential Piece Rate System.

(5) Merrick Differential Piece Rate Plan-

While calculating total earnings of a worker under different incentive wage schemes, the following

four elements must be taken into account: (i) Unit of output, (ii) Standard time, (iii) Time

worked, and (iv) Time saved.

Time Rate Based Premium Plans

Halsey Premium Plan

Under this system, a standard time is fixed for each job or operation. Time rate is guaranteed to a

worker and if he completes the job within standard time or more than the standard time, he is paid

standard rate.

But if the Job is completed in less than the standard time fixed for the job, he is given wages for

the actual hours taken plus bonus equal to one half of the wage of the time saved.

Gross Wages = (Time worked x wage rate) + (½ Time saved x wage rate)

PRACTICE QUESTION

Q. 1

Wage rate per hour

Rs. 1.50

Time allowed for the job

16 hours

Time taken

12 hours.

Required:

1. Calculate the Gross earnings of the worker.

2. Find out effective "rate of earnings"

Solution: (Halsey premium plan)

Gross Earnings

Basic Pay

12 x 1.5

Bonus Pay

½ (4)x 1.5

Effective rate of earning

Rs21/12 hours = Rs. 1.75

Cost & Management Accounting (MGT-402)

Halsey-Weir Premium Plan

Under this method, other things being the same as Halsey Plan, the rate of premium usually

applied is 33.33: 66.67 sharing plan basis. In practice the bonus is on a 50: 50 sharing scheme.

Q. 2

Calculate the total earnings and effective rate of earning per hour from the practice question given

above, if the worker is paid according to Halsey-Weir premium plan.

Solution: (Halsey-Weir premium plan)

Gross Earnings

Basic Pay

12 x 1.5

Bonus Pay

33.33% of (4) x 1.5

Effective rate of earning

Rs20/12 hours = Rs. 1.67

Rowan Premium Plan

This system is similar to the above two plans. The worker is guaranteed at ordinary rate of wages

and bonus is paid in respect of time saved.

Under the Rowan system the bonus hours are calculated as the proportion of the time taken which

the time saved bears to the standard time allowed.

Thus under this system a different method of calculating bonus is applied.

Step I

The bonus rate is calculated as:

Time allowed Actual time taken x 100 = %

Time allowed

Step II

This bonus rate is then applied on the basic pay to calculate the bonus pay.

Basic Pay x bonus rate = bonus pay

Q. 3

Calculate the total earnings and effective rate of earning per hour from the practice question given

above, if the worker is paid under Rowan bonus plan.

Solution: (Rowan premium plan)

Bonus rate = 16 12 x 100 = 25%

Gross Earnings

Basic Pay

12 x 1.5

18.00

Bonus Pay

18 x 25%

4.50

22.50

Effective rate of earning

Rs 22.5/12 hours

= Rs. 1.875

OVERTIME

Normally an employee is required to work for a set number of hours every week. There may

however be occasions where the employer will ask the employee to work for longer hours.

Overtime is the time worked over and above the employee's basic working week.

Cost & Management Accounting (MGT-402)

Overtime must not be confused with flex-time. In a flex-time system an employee is allowed to

work extra hours earlier in the week or month, in return for which he will work fewer hours later

on. His overall number of hours worked remains constant.

Overtime is time that is paid for, usually at a premium, over and above the basic hours for the

period.

Overtime by direct workers might be incurred for two reasons:

- Either to make up for lost time earlier in the production process or

- In order to produce more of the product than was originally anticipated.

Overtime being worked means that more units of a product are produced. However, if the

overtime is being worked to make up for lost production earlier in the process then the units

produced in the overtime may simply be enough to bring production back up to its anticipated

level.

Overtime that is being worked in order to make up for unnecessarily lost production time is

avoidable and should not have occurred.

Overtime that is necessary in order to fulfill customer orders is unavoidable overtime.

Calculating Overtime Pay

Hourly Paid Workers

Hourly paid workers may be paid overtime at various different rates. For example, the hourly rate

of overtime may be the same as the basic rate of pay or higher than the basic rate of pay.

It may either be expressed as a higher monetary amount, or as a proportion of basic pay, such as

'time and a half.

The hourly rate of overtime may vary according to when the overtime is worked. For example the

evening rate may be 'time and a half, whereas the weekend rate may be 'double time'.

The hourly rate may vary with the number of overtime hours worked. For example the first 5

hours may be at 'time and a half, and additional hours at 'double time'.

Weekly Paid Workers

The overtime pay is the number of hours of overtime worked, multiplied by the rate at which

overtime is paid.

Cost & Management Accounting (MGT-402)

PRACTICE QUESTION

S normally works a 35 hour week, and is paid Rs.5 per hour. In one week she works 12 hours of

overtime, one hour each week day, and 7 hours on Saturday.

How much is her overtime-pay if:

(a) She is paid time and a half for all overtime hours?

(b) She is paid time and a half for evening overtime and double time for weekend overtime?

Solution

S's overtime pay is:

(a)

Basic rate of pay

Rs. 5 per hour

Overtime rate of pay

Rs. 5 x 1 ½ times = Rs. 7.50 per hour

Overtime pay

12 hours @ Rs.7.50 per hour = Rs. 90.00

(b)

Basic rate of pay

Rs. 5 per hour

Overtime rate of pay evenings Rs. 5 x 1 ½= Rs. 7.50 per hour Overtime rate of

pay

weekends Rs. 5 x 2

= Rs. 10.00 per hour

Overtime pay 5 hours @ Rs. 7.50 per hour

37.50

7 hours @ Rs. 10.00 per hour

70.00

107.50

(c)

Basic rate of pay

Rs. 5 per hour

Overtime rate of pay -first 8 hours Rs. 5 x 1 ½

= Rs. 7.50 per hour

Overtime rate of pay-excess hours Rs. 5x2

= Rs. 10.00 per hour

Overtime pay 8 hours® Rs. 7.50 per hour

60.00

4 hours® Rs. 10.00 per hour

40.00

100.00

Salaried Staff

Not all salaried staff will be paid overtime. If they are, the rate at which overtime is paid may vary

according to when the overtime is worked, in precisely the same way as for weekly paid employees.

The difference is that the pay of salaried staff is usually expressed as an annual rate, and this must

be converted to an hourly rate before the overtime can be calculated.

This is done by dividing the annual salary by 52 to give the weekly salary, and further dividing this

by the number of hours an employee is contracted to work for.

It should be noted that the contract of employment may override this calculation, setting a rate of

overtime pay.

PRACTICE QUESTION

Alee works a 35 hour week for an annual salary of Rs.18,200. He is expected to work up to 5 hours

of overtime for no extra pay, but thereafter will be paid overtime pay at the rate of time and a half.

One week he works 8 hours of overtime. What is his overtime pay?

Solution

Hint: There are 52 weeks in a year and there are 35 working hours in a week

Alee's basic hourly rate of pay is:

Rs.18,200 x 1/52 x 1/35 =Rs.10

The hourly rate of overtime pay, at time and a half is:

Rs.10 x 1 ½ =Rs.15.00

Alee will not be paid for the first 5 hours of overtime so his overtime pay is:

(8 - 5) hours = 3 hours @ Rs.15 = Rs.45.00

Cost & Management Accounting (MGT-402)

COMMISSION

In some jobs, employees may be remunerated by a basic salary, plus an additional amount

specifically related to that employee's performance.

Commission is an amount paid to an employee based on that employee's performance.

Commission is most commonly paid to salesmen, based on the volume of sales that they have

achieved in a given period. In some cases they may have a very low basic salary, so that

commission forms the largest part of their pay.

In its simplest form, commission will usually be expressed as a percentage of sales achieved in the

previous period e.g. 1% of sales.

Commission may also be paid at different scales, so that the higher the sales, the higher the

commission. For example, a salesman may be paid 2% commission on the first Rs.10,000 of sales,

2.5% on the next Rs.10,000, and 3% on any additional sales.

This basis may be appropriate where an employee sells a large number of small value items. If he

sells instead higher value contracts, the level of commission may vary with the value of the

contract. For example the rate of commission may be 2% for contracts worth up to Rs.10,000,

2.5% for contracts worth up to Rs.20,000, and 3% for larger contracts.

Since the incentive is for the employee to make a large volume of sales, it is important for the

employer to ensure that the salesman is only rewarded for good sales. The commission scheme

may contain a proviso that the commission will only be paid once the customer has paid up, or

once the customer's creditworthiness has been checked.

PRACTICE QUESTION

Haroon is a salesman, selling machinery. He receives a commission of 2% on all sales, with an

additional 0.5% for any item of machinery selling for more than Rs.10,000. In addition he receives

a further 0.5% on sales in excess of Rs.100,000 per month.

During July his total sales amounted to Rs.110,000. Included in this were two expensive machines,

one selling for Rs.12,000, and the other for Rs.17,000.

How much commission does Haroon earn?

Solution

Haroon earns commission of:

Rs.

Basic commission Rs.110,000 x 2%

2,200

Expensive machines Rs. (12,000 + 17,000) x 0.5%

145

Sales over Rs.100,000 Rs.(110,000-100,000) x 0.5%

Total commission

2,395

Cost & Management Accounting (MGT-402)

PROBLEM QUESTIONS

Q. 1

From the information given below calculate the earnings of each employee, under the following

methods of wage payment.

(i)

Halsey Premium Bonus Scheme.

(ii)

Halsey-Weir Premium Bonus Scheme.

(iii)

Rowan Premium Bonus Scheme.

Employee

Time allowed hours per 100 units

Wages per unit Rs.

Hourly rate Rs.

Actual time taken in hours

Actual units produced

200

150

125

Q. 2

Ten men work as a group. When the weekly production of the group exceeds standard (200 pieces

per hour) each man in the group is paid a bonus for the excess production in addition to his wages

at hourly rates. The bonus is computed thus:

The percentage of production in excess of the standard amount is found and one half of this

percentage is considered as the men's share. Each man in the group is paid as a bonus this

percentage of a wage rate of 50 paisa per hour. There is no relationship between the individual

work man's hourly rate and the bonus rate. The following is one week's record:

Days

Hours worked

Production

Monday

22,100

Tuesday

20,600

Wednesday

24,200

Thursday

20,100

Friday

20,400

Saturday

10,200

Total

480

117,600

(i)

Compute the rate and amount of bonus for the week.

(ii)

Compute the total pay of "A" who worked 41 hours and was paid 35 paisa per hour

basic and of "B" who worked 44 hours and was paid 30 paisa per hour basic.

Q. 3 Using the information given below you are required to calculate the amounts earned by each

employee under each of the following remuneration methods:

(i)

Piece work (with guaranteed hourly rates)

(ii)

Hourly rate;

(iii)

Bonus system (under which the employee receives 50% of time savings).

Also calculate the gross wages paid to each employee under each of the above method.

Employee

Time allowed:

Hours per 100 units

Price per unit in Paisa

Guaranteed hourly rate

Re. 0.60

Re. 0.75

Re. 0.50

Actual time taken in hours

Actual units produced

200

125

150

Cost & Management Accounting (MGT-402)

Q. 4

(a) How is incentive wages calculated under (i) Halsey and (ii) Rowan incentive schemes of wages

payment? Explain the difference between them and the advantage to the worker under these two

methods of incentive payment.

(b) From the following data tabulate the total earnings per hour of each worker separately under (i)

Halsey and (ii) Rowan schemes of incentive payment.

(a) Worker

(b) Time allowed hrs.

(d) Basic wages per hrs. in Rs. 2

Q. 5

Kirn is paid commission of 5% on the first Rs.20,000 of sales, and 7,5% on any sales in excess of

this amount. However she is only paid the commission when either the customer has paid for the

order, or has taken out a financing agreement.

In October she made sales of Rs.35,000, However two customers refused to pay or take out a

financing agreement. One had ordered goods costing Rs.1,500, and the other goods costing

Rs.2,500.

How much commission will Kirn receive?

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