Unit 2
Labour and Overheads
Accounting of labour cost
There should be a proper cost accounting system, which will identify the Direct and Indirect Labour Cost. Similarly the cost accounting department should be able to generate and maintain records for time keeping, time booking, idle and overtime, impact of incentive schemes, per unit of Labour, cost due to Labour Turnover and other relevant records. Thus there is a need to control the Labour Cost and it can be done by the combined efforts of various departments.
The guide lines for ascertaining the Labour Cost / Employee Cost are as follows :-
(a) Employee Cost shall be ascertained taking into account the gross pay including all allowances payable along with the cost to the employer of all the benefits.
(b) Bonus whether payable as a statutory minimum or on a sharing of surplus shall be treated as part of Employee Cost. Ex-gratia payable in lieu of or in addition to bonus shall also be treated as part of the Employee Cost.
(c) Remuneration payable to managerial personnel including executive directors on board and other officers of a corporate body under a statute will be considered as part of the Employee Cost of the year under reference, whether the whole or part of the remuneration is considered as a percentage of profits.
(d) Separation costs related to voluntary retirement, retrenchment, termination etc. shall be amortized over the period of benefitting from such costs.
(e) Employee Cost shall not be included any Imputed Costs.
(f) Any subsidy, grant, incentive or any such received or receivable with respect to any employee cost shall be reduced from ascertainment of Cost of the cost project to which such amounts are related.
(g) Any abnormal cost where it is material and quantifiable shall not form part of the Employee Cost.
(h) Penalties, damages paid to statutory authorities or other third parties shall not form part of the Employee Cost.
(i) The cost of free housing, free conveyance and any other similar benefits provided to an employee shall be determined at the total cost of all resources consumed in providing such benefits.
(j) Any recovery from employees towards the facilities provided shall be reduced from the Employee Cost.
(k) Cost of idle time is ascertained by the idle hours multiplied by the hourly rate applicable to idle employee or a group of employee.
(l) Where Employee Cost is accounted at standard cost, variances due to normal reasons related to employee cost shall be treated as part of Employee Cost. Variances due to abnormal reasons shall be treated as part of abnormal cost.
(m) Any change in the cost accounting principles applied for the determination of the Employee Cost should be made only if it is required by law or for compliance with Cost Accounting Standard or change would result in a more appropriate way of presentation of Cost Statement.
Control of labour cost
The factors which need consideration for the purpose of controlling employee cost/labour effectively are as follows:
(a) Assessment of manpower requirements.
(b) Control over time−keeping and time−booking.
(c) Time & Motion Study.
(d) Control over idle time and overtime.
(e) Control over employee turnover.
(f) Wage and Incentive systems.
(g) Job Evaluation and Merit Rating.
(h) Employee productivity
Key takeaways-
1) The cost accounting department should be able to generate and maintain records for time keeping, time booking, idle and overtime, impact of incentive schemes, per unit of Labour, cost due to Labour Turnover and other relevant records.
Time keeping
Time keeping department also plays an important role in labour cost control through maintaining record of each worker’s time in and time out during regular working period and reporting the time of each worker for each department, operation or production order. Thus this department is responsible for recording the attendance time of each worker accurately. This will ensure punctuality and discipline in the company and will have a positive impact on the morale of each worker. Important role of time keeping from the point of view of labour costing and control can be summarized as given below:
(a) It shows the total number of hours worked by each workman and so the calculation of his wage becomes possible. This is applicable where the workers are paid wages as per the time rate.
(b) Time keeping promotes punctuality and discipline amongst the workers. In the absence of the time keeping system, there will be not only indiscipline amongst them but the workers who are otherwise punctual and disciplined will be frustrated.
(c) Certain benefits like pension, gratuity and leave with pay, provident fund, promotion, and salary scale are linked with the continuity of service. Attendance records in this regard, can be helpful in computation of these benefits.
(d) Computation of Labour hours becomes possible through time keeping records. This will be useful in overhead apportionment and absorption, which may be made on the basis of Labour hours.
(e) Time keeping is a statutory requirement under Labour laws.
(f) The time keeping records can be used for further analysis like for fixation of standard time and finding out idle time as well as the efficiency of Labour. It can be used by researchers as well as by Government Authorities for various purposes.
Methods of Time Keeping
(1) Attendance Records: This is the simplest and the oldest method of marking attendance of workers. In this method, every worker signs in an attendance register against his name. Leaves taken by workers as well as late reporting is marked on the attendance register itself.
(2) Disc Method: This is one of the older methods of recording time. A disc, which bears the identification number of each worker, is given to each one. When the worker comes in, he picks up his disc from the tray kept near the gate of the factory and drops in the box or hooks it on a board against his number.
(3) Time Recording Clocks or Clock Cards: This is mechanized method of time recording. Each worker punches the card given to him when he comes in and goes out. The time and date is automatically recorded in the card. Each week a new card is prepared and given to the worker so that weekly calculation of wages will be possible.
(4) Bio−metric Attendance System: According to Bio−metric attendance system, attendance of the employees is marked by recognising an employee based on physical and behavioural traits. An employee’s unique identity like finger print, face and retina image etc. are kept in a database which is matched at the time of marking of attendance before the attendance device for this purpose. Bio−metric attendance system includes finger print recognition system, face recognition system, Time and attendance tracking technology etc.
Time booking
In time keeping we have seen that the basic objective of time keeping is to mark the attendance time, i.e. time in and time out. Time keeping aims at keeping a check on the number of hours spent by a worker in the factory.
The objects of time booking are as follows:-
(i) To determine the productive time spent by the worker on the job or operation. This helps in finding out the idle time and controls the same.
(ii) To determine the quantity and value of work done.
(iii) To determine earnings like wages and bonus.
(iv) To determine the efficiency of workers.
The following methods are used for time booking:-
(1) Daily Time Sheet: In this method, each worker records the time spent by him on the work during the day, for which a sheet is provided to each worker. The time is recorded daily and hence accuracy is maintained. However, the main limitation of this method is lot of paper work is involved as daily sheets are maintained on daily basis by each worker.
(2) Weekly Time Sheets: The only difference between the daily time sheet and weekly time sheet is that these time sheets are maintained on weekly basis. This means that each worker prepares these sheets weekly rather than daily. This helps in reducing the paper work to a great extent. The only care to be taken is that since the information is filled up on daily basis, there may be inaccuracies and hence filling the information should be done on daily basis only.
(3) Job Ticket: Job tickets are given to all workers where time for commencing the job is recorded as well as the time when the job is completed. The job tickets are given for each job and the recording of the time as mentioned above helps to ascertain the time taken for each job. After completing one job, the worker is given another job.
(4) Labour Cost Card: This card is meant for a job, which involves several operations or stages of completion. Instead of giving one card to each worker, only one card is passed on to all workers and time taken on the job is recorded by each one of them. This card shows the aggregate labour cost of the job or the product.
(5) Time and Job Card: This card is a combined record, which shows both, the time taken for completion of the job as well as the attendance time. Therefore there is no need to keep separate record of both, time taken and attendance time.
Key takeaways-
1) Time keeping department also plays an important role in labour cost control through maintaining record of each worker’s time in and time out during regular working period and reporting the time of each worker for each department, operation or production order.
Ideal time
Idle Time Cost represents the wages paid for the time lost during which the worker does not work, i.e time for which wages are paid, but no work is done. As per CAS-7 (Limited Revision 2017), Idle Time is ‘The difference between the time for which the employees are paid/payable to employees and the employees time booked against the cost object’. The causes leading to idle time may be broadly classified into four categories-
(i) Normal, inherent or unavoidable idle time: Time lost between the gate and place of work, break for tea, time interval between one job and another, time for tool setting, adjustment of machine, etc.
(ii) Normal idle time such as waits for jobs, tools, materials or instructions, small power failures, small breakdown of machines and tools, and atmospheric conditions
(iii) Abnormal idle time such as those arising due to breakdown for considerable period, non-availability of raw materials, slack supervision, strikes or lock-outs, fire flood, storm, etc.
(iv) Concealed idle time such as manipulation of job breaking, wastage of time due to underemployment, i.e., unnecessary work like cleaning, grass cutting and gardening to employ idle men, and employment of skilled workers on unskilled jobs.
Treatment of different categories of Idle Time are:-
(a) Unavoidable idle time above would be for insignificant periods. In Cost Accounts, this is allowed to remain merged in the Production Order or Standing Order Number on which the worker was otherwise employed.
(b) Normal Idle Time is booked to factory or works overhead. For the purpose of effective control, each type of idle time, i.e., idle time classified according to the causes is allocated to a separate Standing Order Number.
(c) Abnormal Idle Time would usually be heavy in amount involves longer periods and would mostly be beyond the control of the management. Payment for such idle time is not included in cost and is adjusted through the Costing Profit and Loss Account or included in Profit and Loss Account, when the accounts are integrated.
(d) Tendency to conceal Idle Time should be discouraged. It is a non-effective time and the resultant loss of profit due to reduced production activity but also increases the cost per unit of production as the fixed costs continue to be incurred, irrespective of the reduced quantum of production due to loss of labour time.
Overtime
The Factories Act provides for payment of overtime wages at double usual rates of wages. Payment of overtime consists of two elements, viz., the normal (i.e., usual) amount and the extra payment, i.e., the premium. As per CAS-7, the overtime. Overtime premium is defined as ‘Overtime is the time spent beyond the normal working hours which is usually paid at a higher rate than the normal time rate. The extra amount payable beyond the normal wages & salaries for beyond the normal working hours is called Overtime Premium’.
Treatment of Overtime in Cost Records
As per CAS-7 (Limited Revision 2017), Overtime Premium shall be assigned directly to the cost object or treated as overheads depending on the economic feasibility and specific circumstances requiring such overtime.
1) When overtime is worked due to exigencies or urgencies of the work, the basic / normal payment is treated as Direct Labour Cost and charged to Production or cost unit on which the worker is employed. Whereas the amount of premium (extra amount) is treated as overhead.
2) If overtime is spent at the request of the customer, then the entire amount (including overtime premium) is treated as direct wages and should be charged to the job.
3) When the overtime is worked due to lack of capacity as general policy of the company, then the total amount paid is treated as direct wages which is computed at the estimated rate based on the figures of the previous years.
4) Overtime worked on account of the abnormal conditions such as flood, earthquake, etc., should not be charged to cost, but to costing Profit and Loss Account if integrated accounts are maintained.
Labour turnover
Labour Turnover of an organisation is change in the labour force during a specified period measured against a suitable index. The rate of Labour Turnover in an industry depends upon several factors such as, nature of the industry, its size, location and composition of the labour force.
The causes giving rise to high labour turnover may be broadly classified under the following the heads:
(i) Personnel Causes: Workers may leave employment purely on personal grounds, e.g.,
(a) Dislike for the job, locality or environments.
(b) Domestic troubles and family responsibilities.
(c) Change of line for betterment.
(d) Retirement due to old age and ill health.
(e) Death.
(ii) Unavoidable Causes: In certain circumstances it becomes obligatory on the part of the management to ask some of the workers to leave. These circumstances are:
(a) Retrenchment due to seasonal trade, shortage of any material and other resources, slack market for the product, etc.
(b) Discharge on disciplinary grounds
(c) Discharge due to continued or long absence
(iii) Avoidable Causes: Under this head, may be grouped the causes which need the attention of the management most so that the turnover may be kept low by taking remedial measures. The main reasons for which workers leave are:
(a) Unsuitability of job.
(b) Low pay and allowance.
(c) Unsatisfactory working conditions.
(d) Unhappy relations with co-workers and unsatisfactory behaviour of superiors.
(e) Dispute between rival trade unions.
(f) Lack of transport, accommodation, medical and other factors.
(g) Lack of amenities like recreational centres, schools, etc.
Preventive Costs may be further grouped under the following heads
1. Personnel administration:
Most concerns would have a Personnel Department which is entrusted with recruitment, training, and other problems arising out of the employment of the labour force. Obviously, the entire expenditure of the department cannot be treated as labour turnover costs but a portion of the costs which related to the efforts of the Personnel Manager in maintaining good relationship between the management and the staff should be treated as Preventive Labour Turnover Cost. The labour force remains satisfied if properly looked after and if grievances are sympathetically considered.
2. Medical Service (Preventive and Curative):
Care for own health and that of family members gets prior consideration with the workers who prefer those concerns where medical services are available. Further, a healthy worker is an asset of the firm as he is able to make substantial contribution towards higher efficiency and productivity.
3. Welfare activities and Schemes:
These include facilities like subsidised canteens, co-operative store, laundry and washing services, sports, housing schemes, transport, and educational facilities. These facilities are as good as higher wages offering incentive to the worker to stay with the firm.
4. Miscellaneous Schemes such as Pension or Provident Fund Schemes, Bonus, High Wage and Other Incentive Schemes Greater the advantage these prerequisites offer, the lower will be the rate of Labour Turnover.
Fringe benefits
It is a type of non-monetary benefits provided by employer to employee. Fringe benefits are those expenses which are spent by an employer against the individual employees for their welfare. Normally such expenses do not form a part of their pay packet, e.g., ESI contribution made by an employer. Such expenses may be recovered separately as a percentage on labour cost or at an hourly rate. Alternatively, those may be treated as overheads and apportioned to cost centres on the basis of wages/salary cost.
Key takeaways-
1) Idle Time Cost represents the wages paid for the time lost during which the worker does not work.
2) The Factories Act provides for payment of overtime wages at double usual rates of wages.
3) Labour Turnover of an organisation is change in the labour force during a specified period measured against a suitable index.
4) It is a type of non-monetary benefits provided by employer to employee. Fringe benefits are those expenses which are spent by an employer against the individual employees for their welfare.
The methods of wage payment are-
B. Piece Rate Method
This method is also called as payment by results where the workers are paid as per the production achieved by them. Thus if a worker produces higher output, he can earn higher wages. Under the piece rate system of wage payment the workers receive a flat rate of wages either for time worked or for units manufactured.
C) Bonus System for Indirect Workers
Bonus to indirect workers is paid on the basis of output of the department, saving in time or expenditure against the budgeted, product quality, reduction of waste and scrap and reduction of labour turnover.
D) Indirect Monetary Incentives
These methods aim at giving additional remuneration based on the prosperity of the concern. The following schemes fall in this category:-
(a) Profit Sharing: In this system, the profits of the organization are shared by workers in agreed proportion. The Payment of Bonus Act 1965 in India makes it mandatory to pay minimum bonus of 8.33% of salary and maximum bonus of 20% of salary to the workers.
(b) Co-partnership: In this system, the workers get an opportunity to participate in the ownership of the organization and to receive the part of share of profits. The employees are given assistance to purchase shares of the company. Thus the employees get dividend and bonus also. These schemes help to boost the morale of workers to a great extent.
E) Non-Monetary Incentives
These incentives are given in addition to monetary incentives for further boosting the moral of the employees. Some of the non-monetary incentives are as follows:-
(a) Free education and training.
(b) Medical benefits.
(c) Subsidized canteens.
(d) Superannuation benefits like pensions, gratuity, life assurance schemes etc.
(e) Sports and recreation facilities, housing facilities, long service awards.
(f) Job security, promotion schemes.
(g) Benevolent funds and welfare fund.
Key takeaways-
1) Different wage payment system are price rate method, time rate method, bonus system, indirect monetary benefit, non-monetary benefit.
Halsey
Hasley introduced Premium plan and weir premium plan.
1) Premium plan
This plan was introduced by F.A. Halsey, an American engineer. In this plan, bonus is paid on the basis of time saved. Standard time is fixed for a job and if the actual time taken is less than the same, the worker becomes eligible for bonus. However bonus is paid equal to wages of 50% of the time saved. A worker is assured of time wages if he takes longer time than the allowed time. The formula for computing the total wages is as follows.
Total Earnings = H X R + 50% [S – H] R
Where, H = Hours worked, R = Rate per hour, S = Standard time
2) Weir plan
Under this method, there is only one difference as compared to the Halsey Plan and that is instead of 50% bonus for the time saved, it is 331/3rd % of the time saved. Accordingly the formula for this method is modified as follows.
Total Earnings = H × R + 33 1/3 [S-H]R
H = Hours worked. R = Rate per hour, S = Standard time
Rowan
Mr. James Rowan a premium bonus plan known as Rowan Plan. It is similar to that of Halsey Plan in respect of time saved, but bonus hours are calculated as the proportion of the time taken which the time saved bears to the time allowed and they are paid for at time rate. The formula for computation of total earnings is as follows:-
Total Earnings = H × R + [S – H]/S × H × R
Where H = Hours worked, R = Rate per hour, S = Standard time,
Taylor’s differential price wage
Taylor is regarded as father of scientific management and he has recommended a system of Differential Piece Rate. According to him, there are only two classes of workers, efficient and inefficient. He suggests that while efficient workers should be encouraged to the maximum possible extent, the inefficient workers should be penalized. In order to do this, he has suggested two rates for the two classes of workers. Thus according to Taylor, if the workers are efficient, they should be paid @ 120% of the normal piece rate and if they are inefficient, they should be paid @ 80% of the normal piece rate. For measuring efficiency, each worker will be given a standard production quantity to be produced in the time allowed and the actual production should be compared with the same. If a worker exceeds the standard, he will be regarded as efficient while if he fails to do so, he will be regarded as inefficient. The positive and negative points of this system are as follows:-
Merits:-
(a) There is a very strong incentive to the workers, which helps to achieve higher productivity.
(b) Due to the incentive, best workers are attracted to the company.
(c) This method is quite simple and hence easy to understand.
Limitations:
(a) Slow workers and beginners are penalized severely. Similarly workers get penalized for reasons beyond their control, e.g. medical reasons, accidents etc. Therefore it is said that there is no human element in this system.
(b) In an anxiety to produce more, quality may be neglected in order to achieve higher quantity of production.
Key takeaways-
1) Mr. James Rowan a premium bonus plan known as Rowan Plan.
2) Taylor suggests that while efficient workers should be encouraged to the maximum possible extent, the inefficient workers should be penalized.
Classification of overheads
Classification of overhead is made according to the following basis:
a) Based on Elements:
1) Indirect Materials: As per CAS-3 indirect material cost is defined as ‘Materials, the cost of which cannot be directly attributed to a particular cost object’. For example, lubricants used in a machine
2) Indirect labour: As per CAS-3, indirect employee cost is the employee cost, which cannot be directly attributed to a particular cost object. For example, wages and salaries paid to indirect workers
3) Indirect expenses: As per CAS-3, Indirect Expenses are expenses, which cannot be directly attributed to a particular cost object. For example, rent and taxes, printing and stationery, power, insurance, electricity, marketing and selling expenses etc.
b) Based on Functions of the organisation:
1) Manufacturing overheads: As per CAS-3, Indirect Cost involved in the production process or in rendering service. Manufacturing overheads has different names such as Production Overheads, Works Overheads, Factory Overheads.
2) Administrative overheads: As per CAS-3, Administrative Overheads are defined as Cost of all activities relating to general management and administration of an organisation.
3) Selling and Distribution overheads: As per CAS-3, Selling Overheads, also known as Selling Costs, are the expenses related to sale of products and include all Indirect Expenses in sales management for the organization.
4) Research & Development overheads: Research Cost is defined as the cost of searching for new or improved products, new applications of material, or new or improved methods, process, systems or services. In the modern days, firms spend heavily on Research and Development. Expenses incurred on research and development is known as Research and Development Overheads.
c) Based on the Behaviour:
1) Fixed Overheads: Fixed Costs are stated to be by and large uncontrollable, in the sense they are not influenced by the action of a specified member of an undertaking. For example, the supervisor has practically no control over the fixed costs like depreciation of plant & machinery.
2) Variable Overheads: Variable Costs are those which vary totally in direct proportion to the volume of output. These costs per unit remain relatively constant with changes in production.
3) Semi variable overheads: These are a sort of mixed or hybrid costs, partly fixed and partly variable costs. For example Telephone expenses, include a fixed portion of annual charge plus variable charge according to the calls. Thus total telephone expenses are semi-variable.
Allocation of overheads
CIMA defines Cost Allocation as, ‘the charging of discrete, identifiable items of cost to cost centres or cost units’. In other words allocation is the process by which cost items are charged directly to a cost unit or cost centre. For example, electricity charges can be allocated to various departments if separate meters are installed, depreciation of machinery can be allocated to various departments as the machines can be identified, salary of stores clerk can be allocated to stores department, cost of coal used in boiler can be directly allocated to boiler house division.
Apportionment of overheads
Cost Apportionment is the allotment of proportions of items to cost centers. This process is called as ‘Apportionment’ of overheads. The basis for apportionment is normally predetermined and is decided after a careful study of relationships between the base and the other variables within the organisation.
Principles of Apportionment of Overhead Cost
(i) Services Rendered
The principle followed in this method is quite simple. A production department which receives maximum services from service departments should be charged with the largest share of the overheads. Accordingly, the overheads of service departments are charged to the production departments.
ii) Ability to Pay: This method suggests that a large share of service department’s overhead costs should be assigned to those producing departments whose product contributes the most to the income of the business firm. However the practical difficulty in this method is that, it is difficult to decide the most paying department and hence difficult to operate.
(iii) Survey or Analysis Method: This method is used where a suitable base is difficult to find or it would be too costly to select a method which is considered suitable. For example, the postage cost could be apportioned on a survey of postage used during a year.
(iv)Efficiency Method: Under this method, the apportionment of expenses is made on the basis of production targets. If the target is exceeded, the unit cost reduces indicating a more than average efficiency. If the target is not achieved, the unit cost goes up, disclosing there by, the inefficiency of the department.
Absorption of overheads
Absorption means ‘recording of overheads in Cost Accounts on an estimated basis with the help of a predetermined overhead rate, which is computed at normal or average or maximum capacity’.
In general, the formula for overhead absorption rate is give as:-
Overhead Rate = Amount of Overhead / No of units of the base
Overhead Absorption Rates: For the purpose of absorption of overhead in costs of jobs, processes, or products overhead rates related to suitable factors or bases to be determined. There are several methods in use for determining the overhead rates i.e Actual or Predetermined Overhead Rate, Blanket or Multiple Rates.
The amount of overhead absorbed in costs is the sum total of the overhead costs allotted to individual cost units by application of the overhead rate. When a predetermined rate worked out on the basis of anticipated or budgeted overhead and base is applied to the actual base, the amount absorbed may not be identical with the amount of overhead expenses incurred if either the actual base or the actual expenses or both deviate from the estimates or the budget. If the amount absorbed is less than the amount incurred, which may due to actual expenses exceeding the estimate and / or the output or the hours worked being less than the estimate, the difference denotes under-absorption.
On the other hand if the amount absorbed is more than the expenditure incurred, which may be due to the expense being less than estimate and / or the output or hours worked being more than the estimate, this would indicate over-absorption, which goes to inflate the costs.
Under or over absorption of overhead may arise due to one or the other of the causes given below:-
(a) Error in estimating overhead expenses.
(b) Error in estimating the level of production, i.e the base.
(c) Major unanticipated changes in the methods of production.
(d) Unforeseen changes in the production capacity.
(e) Seasonal fluctuations in the overhead expenses from period to period.
(f) Overhead rate may be applied to the Normal Capacity which may be less than the full operating capacity of the undertaking.
Key takeaways-
1) Allocation is the process by which cost items are charged directly to a cost unit or cost centre.
2) Absorption means ‘recording of overheads in Cost Accounts on an estimated basis with the help of a predetermined overhead rate, which is computed at normal or average or maximum capacity’.
References-
1) S. P. Gupta : Management Accounting.
2) B. K. Mehta & K. L. Gupta : Management Accounting.
3) Manmohan and Goyal : Management Accounting.
4) Hingorani and Others : Management Accounting.
5) R. N. Anthony : Management Accounting.
6) Agarwal and Mehta: Management Accounting.
