CHAPTER THREE : LABOUR COSTING

CHAPTER THREE : LABOUR COSTING

Introduction

In this chapter we will be learning about different remuneration schemes, their suitability in various circumstances and their effect on labour cost. We will also be studying the documents that are used to record labour activity. We will conclude the chapter with a discussion of the analysis and classification of the various elements of labour cost.

Remuneration systems

A wide range of methods may be used by different organisations to remunerate employees. Some employees receive a salary, which is a fixed sum and does not depend on their output or hours of attendance. Other methods may remunerate employees according to their activity level or hours of work. These methods can be grouped into three categories: time-based systems, piecework systems and bonus schemes.

Time-based systems

These are based on the principle that an employee is paid for the hours attended, regardless of the amount of work achieved. The method thus operates by recording the amount of time the employee spends at the workplace. The wages earned are then computed by multiplying the number of hours by the agreed hourly wage rate.

It is common for this system to be supplemented by the payment of a higher rate per hour for working hours in excess of the normal working week. This is known as overtime and it is commonly paid at a premium of between 25 and 100 per cent above the normal hourly rate.

A time-based method of remuneration may be suitable in the following circumstances:

_ where the output is difficult to measure, such as in administrative functions;

_ where activities vary considerably, such as repairing machinery;

_ where quality of output is extremely important and to use other systems might encourage employees to give priority to the speed of their output with the result that quality diminishes.

Example

Amie is employed by H Limited. She works a basic week of 30 hours and is paid GMD8 per hour. If she works overtime this is paid at a premium of 50 per cent above her normal hourly rate (this is known as ‘time-and-a-half’). During the week ended 4 July he worked 35 hours. Her gross wage was:

Basic rate: 35 hours @ GMD8 per hour = GMD280

Overtime premium: 5 hours @ GMD4 per hour = GMD20

Thus, her gross wage was GMD300

Piecework systems

With piecework systems, an employee is paid according to the output achieved. In these systems it is necessary to record the amount of work done by each employee but the amount of attendance time is less significant.

A variation of the basic piecework principle is for the organisation to set a daily target level of activity and for the employee to be paid a higher rate per unit for those completed in excess of the target.

A piecework system is used when quantity of output is important, and quality control can be satisfactorily maintained by other management techniques.

Example

Dawda is employed on a part-time basis by K Limited. He is paid GMD0.40 for each unit he produces up to 100 units per shift. Any units produced above this target are paid at GMD0.50 per unit. Last shift he produced 108 units. His earnings that shift were:

100 @ GMD0.40 = GMD40

8 @ GMD0.50 = GMD4

Thus, his total earnings is GMD44.

Bonus schemes

A variety of bonus and incentive schemes exist. They are all similar and are designed to increase productivity.

The schemes rely on the setting of a target and the comparison of actual performance with that target. The savings which result from the employee’s greater efficiency are then shared between the employee and the employer on a proportionate basis. Usually the employee receives between 30 and 60 per cent of the time saved as a bonus number of hours paid at the normal hourly rate.

Example

Mustapha is a skilled engineer, paid GMD12 per hour. Each job he does has a time allowance and he is paid 50 per cent of any time he saves each week as a bonus paid at his hourly rate.

During the week ended 11 July, John worked for 40 hours and completed jobs having a total time allowed of 47 hours.

John’s earnings were GMD522.

That is,

40 hours @ GMD12 =GMD480

Bonus 3.5 hours@ GMD12 = GMD42

Seven hours were saved against the total time allowed, so there are 3.5 bonus hours.

A wide variety of incentive and bonus schemes exist. In the assessment you must read the description of the scheme carefully before you apply it to the data supplied.

Other aspects of remuneration systems

Guaranteed minimum wage

A guaranteed minimum wage may be included within a piecework system. It protects employees by guaranteeing them a minimum weekly wage based on an hourly rate multiplied by the employee’s number of attendance hours. Note that this is only applied if the level of piecework earnings is below this guaranteed minimum level.

Example

If Mustapha (above) had only produced 50 units but was entitled to a guaranteed minimum wage of GMD30 per shift, he would receive GMD30 even though his piecework earnings were only 50@GMD0.40 = GMD20.

Differential piece rate

Using this system a target number of units is set and different rates per unit are paid depending upon the total number of units achieved. Usually a daily target is You should note that it is usual for the higher rates to apply only to the additional units, not to all of the units achieved.

Other bonuses and benefits

In addition to the above, some organisations provide other bonuses and benefits to their employees. Examples of these include: company cars, staff discounts, subsidised canteen, free health insurance, non-contributory pension schemes,  etc.

Units produced in a day

1–100 units GMD0.40 each

101–129 units GMD0.42 each

130 units and above 0.44 each

These cannot be considered to improve efficiency in the same way as the bonus

schemes described above. However, it is widely believed that they encourage employees to remain with their present employer, and thus reduce labour turnover. Labour turnover is a measure of the number of leavers relative to the size of the workforce. It is normally expressed as a percentage.

Labour turnover for period = (number of leavers replaced ÷ average number of employees) x 100

The level of labour turnover should be minimised because of the cost of recruiting and training employees. For this reason, it is necessary to establish the reason why an employee is leaving. If possible, management should take action to solve the problems which cause people to leave.

Accounting for the cost of labour

Employer’s National Insurance costs

In the Gambia, employees pay income tax, usually under the pay-as-you-earn ( PAYE) system. Employers deduct income tax from gross wages before they are paid to the employee. Employers also deduct the employee’s Social Security Provident Fund Contributions in The Gambia from gross wages to determine the net wage to be paid to the employee. The employer will pay the deducted tax and Social Security Contributions to the relevant authorities on behalf of the employee.

In addition, the employer The Gambia pays employer’s Social Security Contribution based on the level of the employee’s wages. This, then, is an added cost of employment: it is often referred to as an employment-related cost.

Overtime premium

In an earlier example, it is common for hours worked in excess of the basic

working week to be paid at a higher rate per hour. The extra amount is usually referred to as overtime premium.

This overtime premium may be caused by the specific request of a customer who requires a job to be completed early or at a specific time, or may have resulted because of the organisation’s need to complete work which would not be finished without the working of overtime. In the situation caused by the customer, the customer should be advised that overtime would be required and that this cost would be charged to them. Thus, in this situation, the overtime premium can be clearly identified as being caused by that particular task and is a direct cost which should be attributed to it. In other more general circumstances the cost of the overtime premium is regarded as an indirect cost, even the premium that is paid to direct workers, because it cannot be identified with a specific cost unit.

Bonus earnings

The earning of bonuses, if paid on an individual task basis, can be clearly attributed to a particular task and so would be a direct labour cost of this task. However, if the bonus system accumulates the total allowable time and hours worked for a particular pay period and then calculates the bonus based on these totals, any bonus will usually be treated as an indirect cost.

Idle time

Idle-time payments are made when an employee is available for work and is being paid, but is not carrying out any productive work. Idle time can arise for various reasons including machine breakdown, lack of orders or unavailability of materials. Idle time must be recorded carefully and management must ensure that it is kept to a minimum. It will be necessary to take account of idle time if a reconciliation is being performed between an employee’s total attendance time and the total time charged to cost units or cost centres. If there is any difference between these two total times it may be caused by the amount of idle time. Idle time payments are treated as indirect costs in the analysis of wages.

Example: analysis of labour costs

The wages analysis for cost centre 456 shows the following summary of gross pay:

	Direct Employees GMD	Indirect Employees GMD
Basic pay – ordinary hours	48,500	31,800
Overtime pay – basic rate	1,600	2,800
Premium	800	1,400
Bonus paid	5,400	8,700
Total Gross pay	56,300	44,700

Which of these are direct labour costs and which are indirect labour costs?

Solution

There is no indication that the overtime and bonuses can be specifically identified with any particular cost unit. Therefore, the overtime premium and the bonuses are indirect costs, even the amounts which were paid to direct employees. The wages can be analysed as follows:

It would not be ‘fair’ to charge the overtime premium of direct workers to the cost unit which happened to be worked on during overtime hours if this unit did not specifically cause the overtime to be incurred. Therefore, the premium is treated as an indirect cost of all units produced in the period.

The direct labour cost of GMD50,100 can be directly identified with cost units and will be charged to these units based on the analysis in the timesheets. The indirect costs cannot be identified with any particular cost unit and will be shared out over all units, using the methods described in the next chapter.

Summary

The main points that you should understand are as follows:

1. The three main categories of remuneration system are time-based systems, piecework systems and bonus schemes.

2. A differential piece rate system pays different rates per unit depending on the output achieved.

3. The labour turnover rate monitors the percentage of employees that leave the

organisation and are replaced. It should be kept as low as possible.

4. Labour attendance and activity may be recorded on clock cards, daily timesheets and weekly timesheets.

5. Overtime premium is the extra hourly rate paid for working above an agreed number of hours in a period. It is usually an indirect cost unless the overtime has been worked at the specific request of a customer.

PRACTICE QUESTIONS

1.  Gross wages incurred in department 1 in June were GMD54,000. The wages analysis shows the following summary breakdown of the gross pay:

What is the direct wages cost for department 1 in June?

(A) GMD25,185

(B) GMD30,625

(C) GMD34,685

(D) GMD36,065

2.  A manufacturing firm is very busy and overtime is being worked.

The amount of overtime premium contained in direct wages would normally be classed as:

(A) part of prime cost.

(B) factory overheads.

(C) direct labour costs.

(D) administrative overheads.

3.  Which of the following would be classed as indirect labour?

(A) Assembly workers in a company manufacturing televisions.

(B) A stores assistant in a factory store.

(C) Plasterers in a construction company.

(D) An audit clerk in a firm of auditors.

4. The following data relates to a direct employee in production department A:

Normal working day 7 hours

Hourly rate of pay GMD8

Standard time allowed to produce one unit 6 minutes

Bonus payable at basic hourly rate 50% of time saved

What would be the gross wages payable in a day when the employee produces

82 units?

(A) GMD33.60

(B) GMD60.80

(C) GMD65.60

(D) GMD84.00

5. Is the following statement true or false?

If overtime is worked at the specific request of a customer who requires a job to be completed early, the overtime premium incurred is usually treated as a direct cost of the customer’s job. True & False &

6. The following data relates to three employees who work for a company which operates a premium bonus system, where a bonus is paid equal to half time saved, i.e. the Halsey system:

            Employee                          A               B                  C

            Time allowed (hours)       40              40                 40

            Time taken (hours)           37              36                 41

            Basic hourly rate       GMD9       GMD8        GMD10

            Note – there is no overtime premium.

            REQUIRED

            a)    Calculate the gross wages for EACH employee.                                                                             [6]

            b)    Explain the benefits of operating such an incentive scheme to a company.                                     [8]

            c)    Explain the three stock control levels.                                                                                              [6]