Accounting For Labour

Chapter 6
ACCOUNTING FOR
LABOUR
In this chapter we look at the cost of labour. We begin by looking at the ways in which
employees are paid, and the elements of pay in the payroll. We shall then go on to
explain the distinctions between direct and indirect labour costs. The procedures for
accounting for labour costs will then be described, and finally certain aspects of
labour cost control will be explained, such as monitoring labour turnover and
productivity. This chapter covers syllabus area B2.
CONTENTS
1 Labour remuneration
2 Accounting for payroll
3 Relationship between payroll accounting and labour costing
4 Direct and indirect labour costs
5 Documentation of labour time
6 Labour turnover
7 Labour efficiency and utilisation
LEARNING OUTCOMES
At the end of this chapter you should be able to:
• explain, illustrate and evaluate labour remuneration methods
• describe the operation of a payroll accounting system
• distinguish between direct and indirect labour costs
• describe the procedures and documentation required to ensure the correct coding,
analysis and recording of direct and indirect labour
• describe and illustrate the accounting for labour costs
KAPLAN PUBLISHING 87
PAPER MA2 : MANAGING COSTS AND FINANCES
• discuss the relationship between the labour costing system and the payroll accounting
system
• explain the causes and costs of, and calculate, labour turnover
• describe and illustrate measures of labour efficiency and utilisation (efficiency,

capacity utilisation, production volume and idle time ratios).
1 LABOUR REMUNERATION
Most employees are paid a basic wage or salary. They might also earn additional
payments, in the form of a bonus or for working overtime. Some employees do not
earn a basic wage, but instead are paid according to the amount of output they
produce (i.e. they are paid a 'piecework' rate).
You need to understand these basic elements of remuneration, so that you can
calculate the cost of labour in an organisation.
1.1 FIXED BASIC SALARIES OR WAGES
A salary is a fixed basic amount of pay, usually payable every month. The amount of
the basic salary is fixed for a given period of time.
The cost might be expressed as an annual salary such as $52,000 per year or as a
weekly rate such as $1,000 per week.
Employees who are paid a fixed basic salary or wage are required to work a minimum
number of hours, and in many organisations, they are not paid extra if they work for
longer than this minimum. However, in other organisations, employees who work
longer than the minimum number of hours each week or month are entitled to
overtime payments.
1.2 PAYMENT FOR EACH HOUR WORKED
Time-rate employees are paid for the actual number of hours of attendance in a
period, usually each week. A rate of pay will be set for each hour of attendance.
For employees who are paid for the hours they work, it is obviously extremely
important to keep accurate records of the actual number of hours of attendance for
each employee.
EXAMPLE
An employee is paid $25 per hour and is expected to work at least a 48-hour week.
What would he be paid for a standard 48-hour week?
SOLUTION
48 hours × $25 = $1,200
88 KAPLAN PUBLISHING
ACCOUNTING FOR LABOUR : CHAPTER 6
ACTIVITY 1
An employee is paid $15.86 per hour and works 31.5 hours in a particular week.
What would be the employee’s wage for that week?
For a suggested answer, see the ‘Answers’ section at the end of the book.
1.3 PIECEWORK
Piecework is also known as payment by results or output-related pay. It is an

alternative to time-related pay and fixed basic pay.
Definition Piecework is where a fixed amount is paid per unit of output achieved
irrespective of the time spent.
EXAMPLE
If the amount paid to an employee is $9 per unit produced and that employee
produces 80 units in a week how much should be paid in wages?
SOLUTION
80 units × $9 = $720
As far as an employee is concerned piecework or payment by results means that he

can earn whatever he wishes within certain parameters. The harder that he works and
the more units that he produces then the higher will be his earnings.
From the employer’s point of view, the employees are paid for what they produce, not
the hours they work. This can help to control costs.
Piecework is not normally popular with employees. Piecework rates are often low, and
it is difficult to earn a reasonable amount of pay without working long hours. In
addition, the employee gets no income during holidays or when he or she is unable to
work through illness.
There are two other problems associated with payment by results. One is the problem
of accurate recording of the actual output produced. The amount claimed to be
produced determines the amount of pay and, therefore, is potentially open to abuse
unless it can be adequately supervised.
The second problem is that of the maintenance of the quality of the work. If the
employee is paid by the amount that is produced then the temptation might be to
produce more units but of a lower quality.
Conclusion Basic payment methods for employees will either be time-related or

output-related. Time-related methods are either a fixed basic salary or
wage for a minimum number of hours per month or week, or a rate per
hour worked. Output-related methods of payment are some sort of
piecework payment.
1.4 VARIATIONS OF PIECEWORK
Basic piece-rate payments are a set amount for each unit produced e.g. $10 per unit.
However, such systems are rare in practice and there are two main variations that
could be viewed in a similar way to a bonus.
A piece-rate with guarantee operates to give the employee some security if the
employer does not provide enough work in a particular period. The way that the
system works is that if an employee’s earnings for the amount of units produced in the
period are lower than the guaranteed amount, then the guaranteed amount is paid
instead.
EXAMPLE
Jones is paid $6 for every unit that he produces but he has a guaranteed wage of $60
per eight-hour day. In a particular week he produces the following number of units:
Monday 12 units
Tuesday 14 units
Wednesday 9 units
Thursday 14 units
Friday 8 units
Calculate Jones’s wage for this week.
SOLUTION
Total weekly wage

$
Monday (12 × $6) 72
Tuesday (14 × $6) 84
Wednesday (guarantee) 60
Thursday (14 × $6) 84
Friday (guarantee) 60
––––
360
––––
ACTIVITY 2
Continuing with the example of Jones above, what would be his weekly wage if
the guarantee were for $300 per week rather than $60 per day?
A differential piecework system is where the piece-rate increases as successive

targets for a period are achieved and exceeded.
This will tend to encourage higher levels of production and acts as a form of bonus for
payment by results for employees who produce more units than the standard level.
ACTIVITY 3
Payment by results rates for an organisation are as follows:
Up to 99 units per week $1.50 per unit
100 to 119 units per week $1.75 per unit
120 or more units per week $2.00 per unit
If an employee produces 102 units in a week how much will he be paid?
1.5 OVERTIME
If an employee works more than the number of hours set by the organisation as the
working week, the additional hours worked are known as overtime. In many
organisations employees who work overtime are paid an additional amount per hour
for those extra hours that they work.
When the rate per hour for overtime is higher than the basic rate of pay in normal
working hours, the additional pay per hour is known as overtime premium. For
example, suppose that employees are paid a basic rate of $6 per hour, with overtime
paid at time and a half, or at 50% above the basic rate, the overtime premium would
be $3 per hour.
EXAMPLE
The basic hourly rate of an employee is $7.20. Any overtime is paid at 125% of his
normal hourly rate.
What is the amount paid for each hour of overtime, and what is the overtime
premium?
SOLUTION
Rate per hour in overtime = $7.20 × 125% = $9.00.
The overtime premium is $7.20 × 25% = $1.80.
In costing, it is important to distinguish, between the basic rate of pay and the overtime
premium. This is because it is usual to treat overtime premium as an indirect labour
cost, even when the basic rate of pay is a direct labour cost.
The overtime rate is only paid for the hours worked over the basic hours. The basic
hours are paid at the basic rate.
ACTIVITY 4
An employee’s basic week is 40 hours at a rate of pay of $5 per hour. Overtime is paid
at ‘time and a half’.
What is the wage cost of this employee if he works for 45 hours in a week?
Overtime and fixed pay employees
If an employee’s pay is a fixed weekly, monthly or annual amount rather than an

hourly rate of pay, then any overtime payment will still normally be expressed in terms
of a percentage of the basic hourly rate. It is, therefore, necessary to convert the
salary into an effective hourly rate based on the standard working week of the
organisation.
ACTIVITY 5
An employee is paid an annual salary of $19,500. The standard working week for the
organisation is 38 hours per week and the employee is paid for 52 weeks of the year.
Any overtime that this employee works is paid at time and a half.
What is the hourly rate for this employee’s overtime?
1.6 BONUSES
Bonuses are payments to employees on top of their basic pay and any overtime
payments. They may be paid to employees for a variety of reasons. An individual
employee, a department, a division or indeed the entire organisation may have
performed particularly well and it is felt by the management that a bonus is due to
some or all of the employees.
The basic principle of a bonus payment is that the employee is rewarded for any
additional income or savings in cost to the organisation. This may be for example
because the employee has managed to save a certain amount of time on the
production of a product or a number of products. This time saving will save the
organisation money and the amount saved will tend to be split between the
organisation and the employee on some agreed basis.
There are many different types of bonus arrangements. However, these different
arrangements can be categorised as:
• a collective bonus scheme for all employees. In general a bonus will be paid to
employees if the organisation as a whole has performed well in the latest
period. Some of the profits from this above average performance will be shared
with the employees in the form of a bonus. This is known as a profit-sharing
bonus
• a collective bonus scheme for a limited group of employees. In some

organisations bonuses may be determined on a departmental or divisional
basis. If a particular department or division performs well then the employees in
that department or division will receive some sort of bonus
• individual bonus schemes for employees.
Definition A flat rate bonus is where all employees are paid the same amount
of bonus each regardless of their individual salary.
The principle behind such a payment is that all of the employees have contributed the
same amount to earning the bonus no matter what their position in the organisation or
their salary level.
EXAMPLE
Suppose that a small business made a profit of $250,000 in the previous quarter and
the managing director decided to pay out $20,000 of this as a flat rate bonus to each
employee. The business has 50 employees in total including the managing director
earning a salary of $68,000 per annum and Chris Roberts, his secretary, who earns
$28,000 per annum.
How much would the managing director and Chris Roberts each receive as
bonus for the quarter?
SOLUTION
Total bonus $20,000
Split between 50 employees ($20,000/50) = $400 per employee
Managing director’s bonus $400
Chris Roberts’s bonus $400
A percentage bonus scheme is an alternative scheme to a flat rate bonus scheme.
Definition A percentage bonus is where the amount paid to each employee as

bonus is a set percentage of that employee’s annual salary.
The principle behind this method of calculating the bonus payable is to give a larger
bonus to those with higher salaries in recognition that they have contributed more to
the earning of the bonus than those with a lower salary.
In the above example, if the bonus payable were 1.5% of annual salary, the managing
director would receive $1,020 and Chris Roberts would receive $420.
Productivity-related bonuses
A productivity-related bonus is a bonus whereby an employee (or group of employees)

are paid extra for completing their work in less than the expected amount of time. In
other words, if employees achieve higher-than-expected productivity, they are
rewarded.
The principle of a productivity-related bonus or incentive scheme is to encourage the

employees affected to achieve additional output in the time they work.
The basis of bonus schemes in these instances is to set a predetermined standard

time (or target time) for the performance of a job or production of a given amount of
output. If the job is completed in less than the standard time or more than the given
output is achieved in the standard time then this will mean additional profit to the
employer.
This additional profit will then be split between the employer and the employee in
some agreed manner.
EXAMPLE
It is expected that it will take 90 minutes for an employee to make a product.
If the employee makes the product in 60 minutes what is the saving to the
employer if the employee’s wage rate is $15.00 per hour?
SOLUTION
Time saving = 30 minutes
At a wage rate of $15.00 per hour the cost saving is $7.50.
In a productivity-related bonus scheme, the employee will be rewarded with a share of

the cost saving. For example, if the employee receives half of the saving, the bonus
would be paid at the rate of $7.50 per hour saved, which in the case of this example
would amount to a bonus of $3.75.
Conclusion This employee’s efficient work has saved the organisation $7.50. The
basis of a bonus scheme for time-rate workers is that a proportion of
this $7.50 should be paid to the employee as a bonus. The size of the
bonus is for the employer to decide.
ACTIVITY 6
Employee’s wage rate $15 per hour

Time allowed for job 40 minutes
Time taken for job 25 minutes
The company’s policy is to calculate the bonus payable to the employee as 35% of the
time saved on the job.
What is the bonus on this basis?
2 ACCOUNTING FOR PAYROLL

Accounting for payroll is a part of the financial accounting system within an
organisation. The payroll is prepared every time that employees are paid, which is
usually every week or month.
The payroll is a list of each individual employee within the organisation, identifying the
employee by name and employment number, and the department or cost centre for
which the employee works. For each employee, the payroll is used to calculate:
• the employee’s gross pay
• the employer's benefits contribution for the employee.
Gross pay is the employee's total remuneration. The employer's benefits contributions
are additional payments of tax the employer must make to the government for the
employee. For the organisation, the total cost of labour is the sum of gross pay and
employer's benefits contributions, plus any contributions the employer makes to an
employees' pension fund.
The payroll is also used to calculate the deductions from each employee's gross pay,
for:
• income tax
• the employee's benefits contributions
• any contributions by the employee to a pension scheme
• any other deductions, such as payments for trade union membership.
The gross pay minus all deductions is the employee's net pay, or 'take home' pay,
which is the cash payment by the employer to the employee.
The payroll therefore itemises the total labour cost for each employee, the deductions
from pay and the net pay. It also shows the total cost of labour and the total amount of
deductions, for each department or cost centre and for the organisation as a whole.
3 RELATIONSHIP BETWEEN PAYROLL ACCOUNTING AND

LABOUR COSTING
With payroll accounting, the aim is to establish:
• the total amount of wages and salaries payable, deductions from pay and net
pay
• the total cost of wages and salaries, for charging as an expense to the income
statement.
There are two key accounts for recording payroll costs in a financial accounting
system:
• a wages and salaries payable account
• a wages and salaries control account.
Illustrative examples of how these accounts are used are shown below. The wages
and salaries payable account is used for recording deductions from pay and net pay.
The wages and salaries control account is used to establish the total cost of labour for
charging to the income statement.
Wages and salaries payable account
$ $
Bank (net pay) 67,000 Wages and salaries control 100,000
Income tax payable 23,000
Employees' Nat Insurance 10,000
––––––– –––––––
100,000 100,000
––––––– –––––––
Wages and salaries control account

$ $
Wages and salaries payable 100,000 Income statement 115,000
Employer's Nat Insurance 15,000
––––––– –––––––
115,000 115,000
––––––– –––––––
With a labour costing system, the total wages and salaries cost (in the above example,
$115,000) is analysed to calculate the costs of cost units. The first stage of this
analysis is to separate direct labour costs from indirect labour costs, and account for
these accordingly.
In a cost accounting system, instead of charging the wages and salaries cost to the
income statement, the costs are therefore charged to work-in-progress (direct labour)
or production overhead, administration overhead or sales and distribution overhead for
indirect labour costs.
EXAMPLE
A manufacturing business has total wages and salaries costs in June of $115,000.
These total costs consist of:
• direct labour costs $37,000
• indirect production labour $25,000
• administration labour costs $24,000
• sales and distribution labour costs $29,000
These labour costs should be accounted for as follows:

Wages and salaries control account
$ $
Work-in-progress 37,000
Production overhead 25,000
Administration overhead 24,000
Sales and distribution
overhead 29,000
––––––
115,000
––––––
Work-in-progress
$ $
Wages (direct labour) 37,000
Production overheads
$ $
Wages and salaries
(indirect production labour) 25,000
Administration overheads
$ $
Wages and salaries 24,000
Sales and distribution overheads

$ $
Wages and salaries 29,000
4 DIRECT AND INDIRECT LABOUR COSTS

Employees can be classified as either direct labour or indirect labour. Direct labour
means employees who are directly involved in producing goods or services for
customers. Indirect labour means employees who are not directly involved in this
work. Examples of indirect labour employees in a manufacturing business are:
• employees working in administration or selling and distribution
• employees in departments that support production, but are not directly involved
in production, such as staff in production planning, repairs and maintenance
and stores
• employees in departments where production work is carried out, but who are
not themselves directly involved in production work. These include department
supervisors.
In production, direct labour employees are employees in production departments who

work directly on making the products or completing the jobs or contracts for
customers.
The total wages and salary costs of employees can be traced to individual
departments/cost centres. All the labour costs of employees outside direct production
departments are indirect labour, and their costs are indirect labour costs.
An aim in cost accounting is to identify direct labour costs and indirect labour costs.
These are not the same as the costs of direct labour and indirect labour employees.
• All the costs of indirect labour employees are indirect labour costs.
• However, not all the costs of direct labour employees are treated as direct
labour costs. Some of these costs are treated as indirect costs.
Costs of direct labour employees that are usually treated as indirect costs are:
• the costs of idle time
• the costs of overtime premium
• costs of labour time not spent in production, such as the cost of time spent on
training courses, and the cost of payments during time off work through illness.
4.1 IDLE TIME
Definition Idle time or down time is time paid for that is non-productive.
Idle time occurs in most organisations. What is important is that the amount of idle
time and the reasons for it are accurately assessed, reported to management for
corrective action if necessary and treated correctly in terms of allocation of the cost to
products.
The effect of idle time is that for a set number of hours of work, if there is idle time or
non-productive time within that period, then less will be produced than expected.
EXAMPLE
Suppose that a workforce of 10 employees is expected to work a 35-hour week each.

In the production time available it is expected that 175 units will be produced i.e. each
unit requires two hours of labour.
Now suppose that the employees only actually work for 320 of those hours although
they will be paid for the full 350 hours.
How many units would be likely to be made in that week? How would the 30
hours that were paid for but not worked be described?
SOLUTION
The anticipated number of units to be produced would be 160 rather than the
expected amount of 175. However, the workforce would still be paid for the full 350
hours.
The 30 hours paid for but not worked are an example of idle time.
Recording idle time
The amount of hours that are paid for but are not used for production represent
wasted hours for the organisation and warrant close control from management.
To assist control, time booking procedures i.e. timesheets, job cards etc., should
permit an analysis of idle time by cause.
Idle time can be classified as avoidable (or controllable) and unavoidable (or
uncontrollable). Making this classification is often a matter for discretionary judgement.
For example, are the idle time effects of a power cut avoidable? In most situations the
answer is probably not, but if a standby generator was available but not used then the
idle time would be classified as avoidable.
Avoidable idle time
The main causes of avoidable idle time are:
(a) production disruption: this could be idle time due to machine breakdown,
shortage of materials, inefficient scheduling, poor supervision of labour, etc.
(b) policy decisions: examples of this might include run-down of inventory, changes
in product specification, retraining schemes, etc.
Idle time as an indirect labour cost
The labour costs of idle time cannot be charged directly to any individual products (or
other cost units). Instead, they are treated as an indirect cost and included in
production overhead costs.
4.2 OVERTIME
When direct labour works overtime, the basic rate of pay is treated as a direct labour
cost. The overtime premium is usually treated as an indirect cost, and included in
production overheads, although the premium can sometimes be a direct labour cost.
• If the overtime is at the specific request of a customer (for example, to get a job
finished more quickly), the full cost of the overtime work, including the overtime
premium, should be treated as a direct labour cost (e.g. as a direct cost of the
job).
• In all other circumstances, the overtime premium should be treated as an

indirect cost, with only the basic labour cost (i.e. the overtime hours at the basic
rate of pay) treated as a direct cost.
EXAMPLE
During a particular month the workers in a factory worked on production for 2,500
hours. Of these 200 hours were hours of overtime of which 50 hours were to cover lost
production and 150 were spent on an urgent job at the request of a customer.
The basic wage rate was $15.00 per hour and overtime was paid at the rate of time
and a third.
Calculate the total wage cost for the month and show the amount of direct and
indirect labour cost.
SOLUTION
Total wage cost(2,300 hours × $15) + (200 hours × $20) $38,500
This can be broken down as follows:

$
Direct costs
Basic cost of direct workers (2,500 × $15) 37,500
Overtime premium for urgent job (150 × $5) 750
––––––
Total 38,250
––––––
Indirect cost
Overtime premium for lost production (50 × $5) 250
––––––
Total 250
––––––
4.3 IDENTIFYING DIRECT AND INDIRECT LABOUR COSTS
Within a costing system, the task of identifying the costs of indirect labour employees
is quite straightforward. The data in the payroll can be used to identify the cost centre
where the employee works, and the full cost of the employee is recorded as an
indirect cost of the cost centre.
The task of separating the total costs of direct labour into direct and indirect labour
costs is more complicated, because of idle time, overtime premium and other non-
productive time. In addition, in order to measure the costs of different products or jobs,
it is necessary to establish how much time the employee has spent working on each
product or job. To do this, there has to be a system for recording direct labour times,
and allocating the time spent to individual products or jobs.
5 DOCUMENTATION OF LABOUR TIME

The most common methods of recording how much time has been spent on particular
activities, products or jobs are:
• timesheets
• job sheets
• cost cards.
5.1 TIMESHEETS
Definition A timesheet is a record of how a person’s time at work has been

spent.
The total hours that an employee has worked in a day or week are shown on the
employee’s clock card but a breakdown of how those hours were spent will be shown
on the timesheet.
The employee fills out his or her own timesheet on a daily, weekly or monthly basis
depending upon the policies of the organisation.
The employee will enter his name, clock number and department at the top of the
timesheet together with details of the work he has been engaged on in the period and
the hours spent on that work.
The purpose of a timesheet for salaried employees is simply to allocate their costs to
departments or products. No calculations of the amounts payable to the employee are
necessary as these are fixed by the employee’s salary agreement.
EXAMPLE
In the week commencing 28 March 20X4 Bernard Gill from the maintenance
department spent his time as follows:
Monday 28 March 9.30 am – 12.30 pm Machine X
1.30 pm – 5.30 pm Machine X
Tuesday 29 March 9.30 am – 11.00 am Machine X
11.00 am – 12.30 pm Office computer
1.30 pm – 7.30 pm Office computer
Wednesday 30 March Sick leave
Thursday 31 March 9.30 am – 12.30 pm Machine L
1.30 pm – 5.30 pm Machine L
Friday 1 April Holiday
The working day for this organisation is 7 hours per day and any overtime is paid to a
salaried employee of Bernard’s grade at $20.10 per hour.
Write up Bernard Gill’s timesheet for the week commencing 28 March 20X4. His
clock card number is 925734.

SOLUTION
TIMESHEET
Name: Bernard Gill Clock Number: 925734
Department: Maintenance
Week commencing: 28 March 20X4
Date Job Start Finish Hours Overtime
Hrs $
28/3 Machine X 9.30 5.30 7.0
29/3 Machine X 9.30 11.00 1.5
Office computer 11.00 7.30 7.5 2
30/3 Sick leave 9.30 5.30 7.0
31/3 Machine L 9.30 5.30 7.0
1/4 Holiday 9.30 5.30 7.0
––––– –––––
Total hours 37.0 2
––––– –––––
Total overtime payment 40.20
–––––
Foreman’s signature ....................................................
5.2 JOB SHEETS
Job sheets take on an even greater importance for employees who are paid on a
results or time basis. In these situations the sheet is a record of the products produced
and it is also used to calculate the payment due to the employee.
EXAMPLE
Sheila Green is an employee in a garment factory with a clock number of 73645. She
is a machinist and she is paid $8.20 for each dress she machines, $10.10 for a pair of
trousers and $6.50 for a shirt.
In the week commencing 28 March 20X4 she produces 23 dresses, 14 pairs of

trousers and 21 shirts. It took her 28 hours to do this work.
Draft her job sheet for that week.

SOLUTION
JOB SHEET
Name: Sheila Green Clock Number: 73645
Department: Factory
Week commencing: 28 March 20X4
Product Units Code Price Bonus Total
Dresses 23 DRE 8.20 – 188.60
Trousers 14 TRO 10.10 – 141.40
Shirts 21 SHI 6.50 – 136.50
––––––
Gross wages 466.50
––––––
Total hours 28
Foreman’s signature:
Date:
A column is included in the timesheet for any bonus that the employee might earn.
There is no overtime column as a payment by results employee does not earn
overtime.
5.3 COST CARDS: JOB COSTING
Definition A job cost card is a card that records the costs involved in a
particular job.
Instead of a record being kept of the work done by each employee, a record can be
kept of the work performed on each job by all direct labour employees. This must of
course be reconciled to the total amount of work recorded by the employees on their
timesheets or clock cards.
ACTIVITY 7
A cake icer works on a number of cakes in a day and each one is costed as a
separate job. The rate of pay for cake icing is $15.30 per hour. On 28 March 20X4 the
icer worked on the following cakes:
28/3JN 3 hours
28/3KA 5 hours
Prepare job cards for these two jobs showing the amount of labour worked by
the cake icer.

6 LABOUR TURNOVER
Labour costs should be kept under control. There are various reasons why labour
costs might be higher or lower than expected. Three such reasons are:
• labour turnover is higher or lower than usual
• labour efficiency or productivity might be better or worse than usual
• idle time might be high or low. Idle time is money spent on labour costs when no
work is done. The cost of idle time is therefore a wasted expense.
Definition Labour turnover is a measure of the speed at which employees

leave an organisation and are replaced.
Labour turnover is often calculated as:
Average annual number of leavers who are replaced

× 100%
Average number of employees
Labour turnover can be monitored over time, to see whether the rate is rising, falling or
fairly stable. An organisation might have an idea of what is an acceptable rate of
labour turnover, and compare the actual rate against this benchmark.
ACTIVITY 8
On average a company employs 7,000 workers but during the last year 200 of these
workers have resigned and have had to be replaced.
What is the labour turnover for the year?
6.1 COSTS OF LABOUR TURNOVER
Whenever employees leave an organisation, the organisation incurs a cost. The cost
of replacing employees (‘replacement costs’) who have left is not just the obvious
costs of advertising the replacement or paying an employment agency, and the costs
of time spent interviewing, choosing and taking on the new employee. There are also
a number of other less obvious replacement costs such as:
• the costs of training a new employee
• the loss of efficiency whilst new employees are learning the job
• the effect on the morale of the existing workforce when labour turnover is high,
leading to a loss of efficiency.
Costs may also be incurred to reduce labour turnover. These costs are known as
‘preventative costs’ and may include:
• improving employee remuneration or benefits
• improving the working environment
• training existing employees and offering career progression.

ACTIVITY 9
The cost of labour turnover can be classified as preventative or replacement.
Give three examples of each cost.
6.2 CAUSES OF LABOUR TURNOVER
The employee records should show as clearly as possible the reasons for each
employee leaving. If a particular cause is recurrent this should be investigated.
However, often employees leaving do not give the full story of why they are leaving,
therefore, any statistics gathered from this source should be treated with caution.
In some cases, the loss of employees is unavoidable. For example, employees might
retire or move to a different part of the country (or to a different country altogether).
Sometimes, employees leave to take up a job somewhere else that offers more pay,
or represents a career move.
Another cause of turnover can be dissatisfaction with the job, unpleasant working
conditions, or poor interpersonal relationships with a supervisor or colleagues.
Management should try to identify causes of avoidable labour turnover, and think
about whether any measures should be taken to try to reduce the turnover rate.
Conclusion High labour turnover has a high cost to a business that is not
necessarily always obvious. Labour turnover should be closely
monitored and reduced if possible.
7 LABOUR EFFICIENCY AND UTILISATION

Two other reasons why a workforce might produce more or less output than expected
are labour efficiency and labour utilisation.
7.1 EFFICIENT AND INEFFICIENT LABOUR
Definition The labour force of an organisation is described as efficient if it

produces more than the standard amount of goods in a set period of
time.
If the labour force is efficient then it is working faster than anticipated or producing
more goods than anticipated in a set period of time.
This might be because the employees are of a higher grade than anticipated or are
more experienced or motivated or simply better at their job than the average
employee.
Alternatively, it might be due to a better grade of material being used that is easier to
work with or an improved design specification that requires fewer labour hours.
Definition The labour force of an organisation is described as inefficient if it

produces less than the standard amount of goods in a set period of
time.

If the labour force is working more slowly than anticipated or producing less units in a
set period of time than anticipated then the employees will be said to be inefficient.
This inefficiency might be because of poor morale within the workforce, use of
inexperienced or below par employees or workers having an 'off day'.
It could also be due to the use of cheaper or lower grade materials that require more
work or a change in the design specification that requires more hours.
7.2 EFFICIENCY RATIO
Labour efficiency or productivity can be measured by means of an efficiency ratio.

The efficiency ratio compares the time actually taken to do the work and the time that
would have been expected to do the work. The expected time to do a piece of work,
such as the expected time to make one unit of a product, can be measured in
standard hours.
Definition A standard hour is the output expected in one hour of production at

normal efficiency, i.e. the amount of work than can be produced in one
hour under standard conditions
For example, if 2,000 units of an item are produced and the output produced
represents 500 hours of work, then the standard hour would be 4 units per hour.
The standard hour is especially useful as a common measure for combining

heterogeneous (dissimilar) products so that manufacturing performance for a cost
centre (or production unit) as a whole can be assessed. The total expected hours, for
example, of a given level of production of all products could be compared to the actual
hours taken in order to assess the efficiency of all production. This can be done via
the efficiency ratio.
Definition The efficiency ratio is a ratio, expressed as a percentage that

compares the standard hours of work produced with the actual hours
worked. When the output is produced in exactly the time expected, the
efficiency ratio is 100%. When output is produced in less than the
expected time, the ratio is higher than 100%.
The efficiency ratio is calculated as follows:
Actual output measured in standard hours

× 100%
Actual production hours
The efficiency ratio may be referred to as the productivity ratio.
7.3 CAPACITY UTILISATION RATIO
A capacity utilisation ratio can be used to measure the utilisation of labour. Labour
utilisation refers to how much labour time is used, compared to how much available
time was expected.
Definition The capacity utilisation ratio is expressed as a percentage and

compares the actual number of hours actively worked with the
budgeted labour hours for the period.
Actual hours worked

Capacity utilisation ratio = × 100%
Budgeted production hours

7.4 PRODUCTION/VOLUME RATIO OR ACTIVITY RATIO
Definition The production/volume ratio assesses how the overall production

level compares to planned levels, and is the product of the efficiency
ratio and the capacity ratio.
Over 100% indicates that overall production is above planned levels and below 100%
indicates a shortfall compared to plans.
The production/volume ratio is calculated as:
Actual output measured in standard hours

× 100%
Budgeted production hours
The three ratios calculated above can be summarised diagrammatically as follows:
Productio n/volum e r atio
Equals
Cap acity ratio × E fficiency r atio
Conclusion
Ratio What it measures A ratio of more than 100% indicates that
Capacity ratio utilisation Labour worked more hours than had

originally been budgeted
Efficiency ratio productivity Labour have performed their tasks quicker

than was expected in a standard hour
Activity ratio overall production More volume was produced than was
originally budgeted
ACTIVITY 10
The budgeted output for a period is 2,000 units and the budgeted time for the
production of these units is 200 hours.
The actual output in the period is 2,300 units and the actual time worked by the labour
force is 180 hours.
Calculate the three ratios.

7.5 IDLE TIME RATIO
The idle time ratio is another useful ratio because it gives an indication of the
percentage of working hours that were lost as a result of the labour force being ‘idle’
during idle time.
Definition The idle time ratio shows the percentage of labour hours available
that were lost because of idle time.
The idle time ratio is calculated as:
Idle hours
× 100%
Total hours available
ACTIVITY 11
An organisation’s work force were budgeted to work for 40,000 hours during
December. The workforce were actually paid for 50,000 hours but only worked for
42,000 hours due to a machine breakdown in the factory.
Use this information to calculate the idle time ratio for the organisation.
CONCLUSION
This chapter explained the different methods of remunerating employees and how payroll
costs and labour costs are recorded. The distinction between direct and indirect labour costs
has been explained.
Finally, ratios for monitoring and controlling labour turnover, efficiency and utilisation have
been described.
We have now looked at two elements of cost, materials and labour. In the next chapter, we
shall look at other expenses.

KEY TERMS
Overtime – time that is paid for, usually at a premium, over and above the basic hours for
the period.
Overtime premium – the amount paid for overtime in excess of the basic rate of pay.
Piecework – where a fixed amount is paid per unit of output achieved irrespective of the
time spent.
Flat rate bonus – where all employees are paid the same amount of bonus each regardless
of their individual salary.
Percentage bonus – where the amount paid to each employee as bonus is a set
percentage of that employee’s annual salary.
Individual bonus schemes – those that benefit individual workers according to their own
results.
Group bonus scheme – where the bonus is based upon the output of the workforce as a
whole or a particular group of the workforce. The bonus is then shared between the
individual members of the group on some pre-agreed basis.
Timesheet – a record of how a person’s time at work has been spent.
Job card – a card that records the costs involved in a particular job.
Idle time or down time – time paid for that is non-productive.
Direct labour cost – the cost of labour that is directly attributable to a cost unit. It consists of
the cost of direct labour spent actively working on production, but usually excludes any
overtime premium payments.
Indirect labour cost – labour overheads, consisting of all the labour costs of indirect
workers plus the indirect labour costs of direct workers.
Labour turnover – the rate at which employees leave the organisation. A labour turnover
ratio is measured as the numbers leaving in a period as a percentage of the average total
number of employees in the period.
Efficiency ratio – comparison of the expected time for producing output compared with the
actual time, expressed as a percentage.
Capacity ratio – comparison of the actual time worked with the budgeted time for the period,
expressed as a percentage.
Production/volume ratio – assesses how the overall production level compares to planned
levels, and is the product of the efficiency ratio and the capacity ratio.
Idle time ratio – this ratio shows the percentage of working hours available that were lost
because of idle time.

SELF TEST QUESTIONS

Paragraph
1 What is piecework? 1.3
2 What types of bonus scheme are there? 1.6
3 What are timesheets and how are they used? 5.1
4 What are job cost cards? 5.3
5 What is the formula for the labour turnover rate? 6
6 What is the formula for the labour efficiency ratio? 7.2
EXAM-STYLE QUESTIONS
1 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
2 A contract cleaning firm estimates that it will take 2,520 actual cleaning hours to clean
an office block. Unavoidable interruptions and lost time are estimated to take 10% of
the operatives’ time. If the wage rate is $24 per hour, what is the budgeted labour
cost?
A $60,080
B $60,480
C $67,200
D $67,197
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 Gross wages incurred in Department 1 in June were $135,000. The wages analysis
shows the following summary breakdown of the gross pay:
Paid to Paid to
direct labour indirect labour
$ $
Ordinary time 62,965 29,750
Overtime
Basic pay 13,600 8,750
Premium 3,400 2,190
Shift allowance 6,750 3,495
Sick pay 3,450 650
––––––– –––––––
$90,165 $44,835
––––––– –––––––
What is the direct wages cost for Department 1 in June?
A $62,965
B $76,565
C $86,715
D $90,165
5 An employee’s basic week is 35 hours at a rate of pay of $22 per hour. Overtime is
paid at ‘time and a half’. During the week the employee worked 42 hours.
What is the wage cost for this employee for the week?
$_____ (Fill in the missing number to the nearest 1 decimal place)
6 An organisations’ bonus policy is to pay a bonus to employees at 40% of the time

saved on production. It has gathered the following information for one of its
employees:
Employee’s wage rate $15.00 per hour
Time allowed for job 60 minutes
Time taken for job 50 minutes
Calculate the bonus to be paid to the employee.
A $1.00
B $2.50
C $12.50
D $17.50

7 An organisation uses three different ratios to assess the performance of it labour.

Match each ratio with the correct potential use.
Capacity Efficiency Activity

Ratio
ratio ratio ratio
A measure of productivity
A measure of overall production
A measure of utilisation
Place a tick in the appropriate box
8 An organisation had budgeted for 60,000 units to be produced in February and the
budgeted time for the production of these units is 5,000 hours.
The actual output in February was 60,300 units and the actual time worked by the
labour force was 6,000 hours.
What is the value of the labour efficiency ratio?
A 84%
B 100%
C 119%
D 120%
9 An organisation had budgeted for 600 units to be produced in a week and the
budgeted time for the production of these units is 40 hours.
The actual output in the week was 540 units and the actual time worked by the labour
force was 32 hours.
What is the value of the capacity utilisation ratio?
A 64%
B 80%
C 112%
D 125%
10 An organisation had budgeted for 3,000 units to be produced in a period and the
budgeted time for the production of these units is 24,000 hours.
The actual output in this period was 3,500 units and the actual time worked by the
labour force was 30,000 hours.
What was the labour production/volume ratio for the period?
_____% (fill in the answer to the nearest full percentage)
For the answers to these questions, see the ‘Answers’ section at the end of the book.


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Chapter 6

2 Accounting for payroll

3 Relationship between payroll accounting and labour costing

4 Direct and indirect labour costs

5 Documentation of labour time

7 Labour efficiency and utilisation

At the end of this chapter you should be able to:

• explain, illustrate and evaluate labour remuneration methods

• describe the operation of a payroll accounting system

• distinguish between direct and indirect labour costs

• describe and illustrate the accounting for labour costs

• describe and illustrate measures of labour efficiency and utilisation (efficiency,

1.1 FIXED BASIC SALARIES OR WAGES

1.2 PAYMENT FOR EACH HOUR WORKED

What would he be paid for a standard 48-hour week?

48 hours × $25 = $1,200

What would be the employee’s wage for that week?

Piecework is also known as payment by results or output-related pay. It is an

As far as an employee is concerned piecework or payment by results means that he

Conclusion Basic payment methods for employees will either be time-related or

1.4 VARIATIONS OF PIECEWORK

Calculate Jones’s wage for this week.

Total weekly wage

A differential piecework system is where the piece-rate increases as successive

Payment by results rates for an organisation are as follows:

Up to 99 units per week $1.50 per unit

100 to 119 units per week $1.75 per unit

120 or more units per week $2.00 per unit

If an employee produces 102 units in a week how much will he be paid?

Rate per hour in overtime = $7.20 × 125% = $9.00.

The overtime premium is $7.20 × 25% = $1.80.

Overtime and fixed pay employees

If an employee’s pay is a fixed weekly, monthly or annual amount rather than an

What is the hourly rate for this employee’s overtime?

• a collective bonus scheme for a limited group of employees. In some

• individual bonus schemes for employees.

Total bonus $20,000

Split between 50 employees ($20,000/50) = $400 per employee

Managing director’s bonus $400

Chris Roberts’s bonus $400

A percentage bonus scheme is an alternative scheme to a flat rate bonus scheme.

Definition A percentage bonus is where the amount paid to each employee as

A productivity-related bonus is a bonus whereby an employee (or group of employees)

The principle of a productivity-related bonus or incentive scheme is to encourage the

The basis of bonus schemes in these instances is to set a predetermined standard

It is expected that it will take 90 minutes for an employee to make a product.

Time saving = 30 minutes

At a wage rate of $15.00 per hour the cost saving is $7.50.

In a productivity-related bonus scheme, the employee will be rewarded with a share of

Employee’s wage rate $15 per hour

What is the bonus on this basis?

2 ACCOUNTING FOR PAYROLL

3 RELATIONSHIP BETWEEN PAYROLL ACCOUNTING AND

• a wages and salaries payable account

• a wages and salaries control account.

Wages and salaries control account

• direct labour costs $37,000

• indirect production labour $25,000