f2 07 Labour costs

Chapter07 Labor costs

Priority = High Exam Guidance

You will be expected to illustrate different remuneration policy and incentive schemes. Their characteristics must be always in your mind. And you must be familiar with the computation of total pay of employee. You will also need to be aware of the procedures and documents required for recording labour costs. 1. Measuring labour activity 1.1 Corresponding concepts

1.1.1 Production is the quantity or volume of output produced.

1.1.2 Productivity is a measure of the efficiency with which output has been produced. It is also called efficiency ratio.

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Expected hours Productivity/ = efficiency ratio Actual hours Actual output = Expected output Ratio > 100% : efficient labour Ratio < 100%: inefficient labour

Example:

Suppose that an employee is expected to produce 3 units in every hour that he works. The standard rate of productivity is 3 units per hour. If, during one week, the employee makes 126 units in 40 hours of work the following comments can be made.

1.1.3 Standard hour of production is a concept used in standard costing, and means the number of units that can be produced by one worker working in the standard way at the standard rate for one hour.

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Standard hour Budgeted output of production =

Budgeted hours 1.1.4 Production volume ratio

Expected hours to make output Production = volume ratio Budgeted hours Output measured in expected or standard hours = Budgeted hours Actual output = Budgeted output Ratio > 100%: worked above capacity Ratio < 100%: worked below capacity

1.1.5 Capacity ratio represents how much production capacity is utilized. Actual hours taken Capacity ratio =

Budgeted hours

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Relationship between the three ratios Production volume ratio

= Efficiency ratio X capacity ratio

Example:

Rush and Fluster Co budgets to make 25,000 standard units of output(in four hours each) during a budget period of 100,000 hours. Actual output during the period was 27,000 units which took 120,000 hours to make. Required:

Calculate the efficiency, capacity and production volume ratios.

1.2 How to enhance production and productivity?

Production can be increased by the following ways. a) Working overtime b) Hiring extra staff

c) Sub-contracting some work to an outside firm d) Managing the work force so as to achieve more output.

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Productivity would be improved if a production department produces the same amount of output as soon as possible.

1.3 Effect of productivity on cost

An increase in productivity will reduce labour cost per unit. Example:

Clooney Co has a production department in its factory consisting of a work team of just two men, Doug and George. Doug and George each work a 40 hour week and refuse to do any overtime. They are each paid $100 per week and production overheads of $400 per week are charged to their work.

ⅰ. In week one, they produce 160 units of output

between them. Productivity is measured in units of output per man hour.

ⅱ. In week two, management pressure is exerted on

Doug and George to increase output and they produce 200 units in normal time.

ⅲ. In week three, Doug and George agree to work a

total of 20 hours of overtime for an additional

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$50 wages. Output is again 200 units and overhead charges are increased by $100.

［2002_dec Section A _20］There would be an increase in the total cost for labour as a result of: (i) additional labour being employed on a temporary basis. (ii) a department with spare capacity being made to work more hours. (iii) a department which is at full capacity switching from the production of one product to another. Which of the above is/are correct? A (i) only B (ii) only C (iii) only D (i) and (iii) only

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［Answer］A

1.4 Effect of automation on productivity

Rising wage rates have increased automation, which in turn has improved productivity and reduced costs. Where automation is introduced, productivity is often, but misleadingly, measured in terms of output per man-hour. A new measure of productivity is required, that is output per machine hour.

Example:

Suppose, for example, that a work-team of six men (240 hours per week) is replaced by one machine (40 hours per week) and a team of four men (160 hours per week), and as a result output is increased from 1,200 units per week to 1,600 units.

2. Remuneration policies

2.1 Effect of labour remuneration policies

a) The morale and efficiency of employees

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b) The cost of finished goods and services

2.2 Time work (day-rate system)

Employees are paid a basic rate per hour, day or week irrespective of production achieved.

Wages = Hours worked × rate of pay per hour

If an employee works for more hours than the basic daily requirement he may be entitled to an overtime payment.

If an employee works unsocial hours he may be entitled to a shift premium.

Summary of day-rate system a) They are easy to understand. b) They do not lead to very complex negotiations when they are being revised.

c) They are most appropriate when the quality of output is more important than the quantity, or where there is no basis for payment by performance. d) Basic time rate provides no incentive to improve productivity and close supervision is necessary, thus bonuses or commissions are often paid to

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encourage efficient and effective working.

Its effect on the cost per unit

［1-2_pilotpaper Section A _22］Scaynes employs two types of labour: skilled workers, considered to be direct workers, and semi-skilled workers, considered to be indirect workers. Skilled workers are paid ￡10 per hour and semi-skilled ￡6 per hour.

The skilled workers have worked 30 hours overtime this week, 10 hours on a specific order and 20 hours on general overtime. Overtime is paid at a rate of time and a half.

The semi-skilled workers have worked 45 hours overtime, 15 hours for a specific order at a customer’s request and the rest for general purposes. Overtime again is paid at time and a half.

What would be the total overtime pay considered to be a direct cost for this week? A ￡195 B ￡285 C ￡350

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D ￡485

［Answer］D

DirectcostSkilled workersSpecific overtime(10 × ￡10 × 1.5)General overtime(20 × ￡10 × 0.5)Semi-skilledSpecific overtimeGeneral overtime

2.3 Piecework schemes

Indirectcost150200100135485270370 Under this method, a fixed amount is paid per unit of output achieved, irrespective of time spent.

Wages=Units produced × Rate of pay per unit

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A guaranteed minimum wage will make them not to suffer loss of earnings when production is low through no fault of their own.

Where an employee makes several different types of product, a standard time allowance make it possible to add up the units to arrive at a total of piecework hours for payment purposes.

Differential piecework schemes offer an incentive to employees to increase their output by paying higher rates for increased levels of production.

What is conversion cost?

Summary of piecework schemes a) They enjoy fluctuating popularity. b) They are occasionally used by employers as a means of increasing pay levels.

c) They are often seen to drive employees to work too hard to earn a satisfactory wage.

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[2006-Dec-44] An organization operates a piecework system of remuneration, but also guarantees its employees 80% of a time-based rate of pay which is based on $20 per hour for an eight hour working day. Three minutes is the standard time allowed per unit of output. 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's gross pay for that day? A. $128 B. $144 C. $160 D. $180

Answer: D

Example:

The following levels of output produced in one day: Normal working day 8 hours 12 / 42

Hourly rate of pay (time ?5.50 per hour basis) Standard time allowed to 3 minutes produce one unit Piecework rate ?0.10 per standard minute Premium bonus 75% of time saved, in addition to hourly pay Required: For the following levels of output produced in one day:

a) 80 units; b) 120 units; c) 210 units; Calculate earnings based on:

1) Piecework, where earnings are guaranteed at 80% of time-based pay,

2) Hourly pay with premium bonus. 2.4 Bonus/incentive schemes

The characteristics of bonus/incentive schemes. a) Employees are paid more for their efficiency. b) The profits arising from productivity improvements are shared between employer and employee.

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c) Morale of employees is likely to improve since they are seen to receive extra reward for extra effort.

The conditions required to operate successfully for a bonus/incentive scheme.

a) Its objectives should be clearly stated and attainable by the employees. b) The rules and conditions of the scheme should be easy to understand.

c) It must win the full acceptance of everyone concerned. d) It should be seen to be fair to employees and employers.

e) The bonus should ideally be paid soon after the extra effort has been made by the employees.

f) Allowances should be made for external factors outside the employees' control which reduce their productivity (machine breakdowns, material shortages).

g) Only those employees who make the extra effort should be rewarded. h) The scheme must be properly communicated to employees.

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2.4.1 High day-rate system

A high day-rate system is a system where employees are paid a high hourly wage rate in the expectation that they will work more efficiently than similar employees on a lower hourly rate in a different company.

Example:

If an employee would make 100 units in a 40 hour week if he were paid $2 per hour, but he were paid $2.50 per hour, if output is 120 units. Production overhead is added to cost at the rate of $2 per direct labour hour, costs per unit of output would be lower with the efficiency rising.

The advantages of high day-rate system

a) It is simple to calculate and easy to understand. b) It guarantees the employee a consistently high wage.

The disadvantages of such schemes are as follows.

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a) Employees cannot earn more than the fixed hourly rate for their extra effort. b) There is no guarantee that the scheme will work consistently.

c) Employees may prefer to work at a normal rate of output.

Example:

X Ltd has an average of 42 workers employed in one of its factories in a period. The company pays a basic rate of ?4.60 per hour to all its direct personnel. This is used as the standard rate. In addition, a factory wide bonus scheme is in operation. A bonus of half of the efficiency ratio in excess of 100% is added as a percentage to the basic hourly rate, for example if the efficiency ratio is 110%, then the hourly rate is ?4.83 (i.e. ?4.60 + (5% X ?4.60)). During the period, 114,268 units of the company’s single product were manufactured in 4,900 hours. The standard hour is 22 units.

Required:

Calculate the hourly wages rate paid and total wages for the period.

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4900*22=107800

(114268-107800)/107800=6%

2.4.2 Individual bonus schemes

Individual employees qualify for a bonus on top of their basic wage, with each person's bonus being calculated separately.

To be successful, it must take account of the following factors.

a) Each individual should be rewarded for the work done by that individual. b) Work should be fairly routine, so that standard times can be set for jobs.

c) The bonus should be paid soon after the work is done, to provide the individual with the incentive to try harder.

2.4.3 Group bonus schemes

A group bonus scheme is an incentive plan which is related to the output performance of an entire group of workers, a department, or even the whole factory.

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The advantages of group bonus schemes.

a) They are easier to administer because they reduce the clerical effort required to measure output and calculate individual bonuses. b) They increase co-operation between fellow workers. c) They have been found to reduce accidents, spoilage, waste and absenteeism.

Serious disadvantages would occur in the following circumstances.

a) The employee groups demand low efficiency standards as a condition of accepting the scheme. b) Individual employees are browbeaten by their fellow workers for working too slowly.

Example:

Which of the following statements is/are true about group bonus schemes?

(i) Group bonus schemes are appropriate when increased output depends on a number of people all making extra effort

(ii) With a group bonus scheme, it is easier to award each individual's performance

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(iii) Non-production employees can be rewarded as part of a group incentive scheme A. (i) only

B. (i) and (ii) only C. (i)and (iii) only

Answer: C

2.4.4 Profit sharing schemes

A profit sharing scheme is a scheme in which employees receive a certain proportion of their company's year-end profits.

The advantage of these schemes is that the company will only pay what it can afford out of actual profits and the bonus can be paid also to non-production personnel.

The disadvantages of profit sharing are as follows. a) Employees must wait until the year end for a bonus. The company is therefore expecting a long-term

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commitment to greater efforts and productivity from its workers without the incentive of immediate reward. b) Factors affecting profit may be outside the control of employees, in spite of their greater efforts.

c) Too many employees are involved in a single scheme for the scheme to have a great motivating effect on individuals.

2.4.4.1 Incentive schemes involving shares

A share option scheme gives its members the right to buy shares in the company at a set date in the future and at a price usually determined when the scheme is set up. Golden Handcuffs

An employee share ownership plan（ESOP） is a scheme which acquires shares on behalf of a number of employees, and it must distribute these shares within a certain number of years of acquisition.

Those schemes make workers feel they have a stake in the company which employs them.

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The disadvantages of these schemes are as follows. a) The benefits are not certain, as the market value of shares at a future date cannot realistically be predicted in advance. b) The benefits are not immediate, as a scheme must be in existence for a number of years before members can exercise their rights.

2.4.4.2 Value added incentive schemes Value added

= sales - cost of bought-in materials and services

The advantage of value added over profit as the basis for an incentive scheme is that it excludes any bought-in costs, and is affected only by costs incurred internally, such as labor.

Example:

Swetton Tyres Co manufactures a single product. Its work force consists of 10 employees, who work a 36-hour week exclusive of lunch and tea breaks. The standard time required to make one unit of the product is two hours, but the current efficiency ratio

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(or productivity) being achieved is 80%. No overtime is worked, and the work force is paid $4 per attendance hour.

Because of agreements with the work force about work procedures, there is some unavoidable idle time due to bottlenecks in production, and about 4 hours per week per person are lost in this way.

The company can sell all the output it manufactures, and makes a 'cash profit' of $20 per unit sold, deducting currently achievable costs of production but before deducting labour costs.

An incentive scheme is proposed whereby the work force would be paid $5 per hour in exchange for agreeing to new work procedures that would reduce idle time per employee per week to 2 hours and also raise the efficiency ratio to 90%. Required:

Evaluate the incentive scheme from the point of view of profitability.

[2006-Dec-SectionA-11] A jobbing company operates a

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premium bonus scheme for its employees of 75% of the time saved compared with the standard time allowance for a job, at the normal hourly rate. The data relating to Job 1206 completed by an employee is as follows:

Allowed time for Job 1206 4 hours Time taken to complete 3 hours Job 1206 Normal hourly rate of pay $8 What is the total pay of the employee for Job 1206? A. 24 B. 30 C. 32 D. 38

Answer: B

3. Recording labour costs 3.1 Personnel department

Responsibilities

a) Engagement, transfer and discharge of employees. b) Classification and method of remuneration.

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c) Prepare personnel record card d) Maintain records of overtime and shift working. e) Issuing reports to management on normal and overtime hours worked, absenteeism and sickness, lateness, labour turnover and disciplinary action.

3.2 Production planning department

This department is responsible for the following. a) Scheduling work b) Issuing job orders to production departments c) Chasing up jobs when they run late

3.3 Timekeeping department

The timekeeping department is responsible recording the attendance time and job time of following.

a) The time spent in the factory by each worker b) The time spent by each worker on each job

The relevant use of this information P148

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for the

3.3.1 Attendance time

Time of absence/arrival/breaks/departure should be included in an attendance record.

3.3.2 Job time

When the work is not repetitive, the following records are required.

a) Daily time sheets b) Weekly time sheets c) Job cards d) Piecework ticket/Operation card

3.3.3 Idle time

The idle time ratio is useful because it shows the proportion of available hours which were lost as a result of idle time.

Idle time ratio=idle time÷total time

Clock cards

These record the time of arrival, time of breaks and

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time of departure for employees.

Time sheets

These record how employees’ time has been spent.

Job cards

These prepared for each job. When an employee works on a job he records on the job card the time spent on that job. Job cards also carry instructions to the operator on how the job is to be carried out.

Route cards

These are similar to job cards, except that they follow the job through the works and carry details of all operations to be carried out.

Idle time cards

These cards record the unproductive hours incurred by the employees.

Piecework ticket /Operation cards

Operation card records the total number of items produced and the number of rejects. Payment is only

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made for ‘good’ production.

It is important to note that:

- Wages are calculated based on clock cards/operation cards.

- Production costs are obtained from the time sheets/job cards/route cards.

[2006-Jun-SectionA-15] The following statements refer to situations occurring in Process Q of an organisation which operates a series of consecutive processes:

(i) Direct labour is working at below the agreed

productivity level.

(ii) A machine breakdown has occurred. (iii) Direct labour is waiting for work to be completed

in a previous process.

Which of these situations could give rise to idle time?

A (i)and (ii) only B (i)and (iii) only C (ii) and (iii) only D (i)，(ii) and (iii)

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Answer: C

3.4 Wages department

Responsibilities of the payroll department.

a) Preparation of the payroll and payment of wages. b) Maintenance of employee records.

c) Summarizing wages cost for each cost centre. d) Summarizing the hours worked for each cost centre.

e) Summarizing other payroll information eg bonus payment, pensions etc.

f) Providing an internal check for the preparation and payout of wages.

3.5 Cost accounting department

Responsibilities of cost accounting department.

a) The accumulation and classification of all cost data (which includes labour costs). b) Preparation of cost data reports for management.

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c) Analysing labour information on time cards and payroll.

Analyses of labour costs are used for the following. a) Charging wages directly attributable to production to the appropriate job or operation. b) Charging wages which are not directly attributable to production as follows.

(i) Idle time of production workers is charged to

indirect costs as part of the overheads.

(ii) Wages costs of supervisors, or store assistants

are charged to the overhead costs of the relevant department.

c) Producing idle time reports which show a summary of the hours lost through idle time, and the cause of the idle time. 4．Labour turnover

4.1 Measuring labour turnover Labour turnover rate

=Replacements ÷ Average number of employees in

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period

Example:

Revolving Doors Inc had a staff of 2,000 at the beginning of 20X1 and, owing to a series of redundancies caused by the recession, 1,000 at the end of the year. Voluntary redundancy was taken by 1,500 staff at the end of June, 500 more than the company had anticipated, and these excess redundancies were immediately replaced by new joiners.

500/[(1000+2000)/2]=0.33

Example:

A company had 30 direct production employees at the beginning of last year and 20 direct production employees at the end of the year. During the year, a total of 15 direct production employees had left the company to work for a local competitor. The labour turnover rate for last year was: A. 16.7% B. 20.0%

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