In Labour Costs, two main areas are to be considered.
1. Payment System
2. Direct Labour Costs and Indirect Labour Costs
PAYMENT SYSTEMS
There are two types of payment systems. Payment can be made:
1. Hourly Rate
2. Piece Work Rate
3. Bonus System
It may be possible that there may be a hybrid (combination) of both ‘Hourly Rate’ and ‘Piece Work Rate’. We may get situation of different combinations which may be:
Basic Rate + Piece Work or Bonus (Bonus for exceptional level of performance)
1. HOURLY RATE (When Work is done on hour basis)
In case of Hourly rate, relationship of direct labour cost and variable cost is difficult to identify.
In most of the cases, labour cost is paid ‘per hour’ and hourly paid rates may depend on:
1. Basic Rate / Normal Hour Rate
Basic hour is usually paid for each hour worked.
Basic rate shall be applied to hours specifically spent on production of unit.
Basic Rate for Basic hours / Normal hours
Normal working hours are of 8 hours per day. Normal hour may be more or less than 8 hours. Normal hours are required for calculation of ‘Overtime Premium’.
Basic Rate for Productive hours / Actual hours
Hours actually spent on production of a unit
2. Overtime Premium
Overtime is mostly given as the percentage of Basic Rate.
Overtime Premium hours = Actual hours paid – Basic Hours
Example for Hourly Rate
A has 40 (8 x 5) hours per week as normal hours
His Basic / Normal hour rate is £10/hour
He is paid Overtime premium at 50% of Basic Rate
He worked for 50 hours.
Solution:
Payment for 50 hours
Basic Rate 50 x £10 = £500
Overtime Premium 10 x (£10 x 0.50) = £ 50
Total payment = 550
2. PIECE WORK (In relation to the Work Done)
Piece work generally shows as purely direct labour cost and variable cost.
GUARANTEED MINIMUM WAGE RATE (GMW)
It is a minimum amount that must be paid to the worker. He could not be paid less than this limit.
GMW separately / instead of Piece Work Rate
If the earnings are less than Guaranteed Minimum Wages Rate (GMW), wages shall be paid separately / instead of Piece Work Rate. It means wages must be paid without considering piece work rate.
GMW in addition to Piece Work Rate
Worker will get at Guaranteed Minimum Wages Rate (GMW) plus the Piece Work Rate (PWR).
GMW + PWR
Example for Piece Work
Payment is based on £2/unit of output
Guaranteed Minimum wage (GMW) is £250 if the earnings are below threshold of £250.
So in this case, GMR is paid separately of piece work rate. It is not being paid additionally to piece rate.
Units Produced Wages at Rate Earnings
100 100 x £2 = £200 £250
200 200 x £2 = £400 £400
300 300 x £2 = £600 £600
In exam, examiner may change the piece work rate from one level of activity to another level of activity. The example may be:
Example for changing Piece work rate with level of activity
Units
£2/units 1 – 100
£2.4/units 101 – 200
£2.6/units 201 – 300
Calculate wages by applying above table if 210 units are produce.
£
100 x £2 = 200
100 x £2.4 = 240
10 x £2.6 = 26
466
3. BONUS SYSTEM
Bonus is measured on the efficiency of the worker. Normally it is taken as difference between units expected to produce and units actually produced.
Bonus payments cannot be associated to production therefore it is an indirect cost.
More efficient = producing more than expected
Difference between STANDARD HOURS and ACTUAL HOURS
Standard hours (expected efficiency) Expected hours for the actual units produced
Actual hours Actual hours worked
Standard hours of actual production = Standard hours per unit x Actual units produced
OR
Standard hours of actual production = Actual units produced / Units to be produced per Hour
Example for Bonus System
Units produced per Hour = 5 units/hour
Actual Production = 250 units
Actual hours worked = 40 hours
Basic Rate = £12/hour
Bonus is based on 60% of the basic rate per hour saved.
Solution:
Standard Hours of 250units = Actual units produced / Units to be produced per Hour
= 250 units / 5units per hour
= 50 hours
Saved Hours = Standard hours – Actual hours
= 50 hours - 40 hours
= 10 hours
50 hours should be spent for 250 units produced.
But 250 units actually produced in 40 hours. Worker showed more efficiency and saved 10 hours. He should get bonus.
Basic Rate £
40hours x £12/hour = 480
Bonus
(50 hours – 40 hours) x (£12 x 60%) = £72
Total wages / salary = £552
DISTINCTION MUST BE MADE BETWEEN 1. Standard hours / Expected hours 2. Actual hours / Productive hours 3. Basic hours / Normal hours 4. Actual hours paid |
Hours Saved for Bonus = Standard hours – Actual hours Overtime premium hours = Actual hours or Actual hours paid – Basic hours |
Idle time hours = Actual hours paid – Productive hours |
DISTINCTION OF DIRECT LABOUR COST AND INDIRECT LABOUR COST
Labour Cost is divided into:
1. Direct Labour Cost
2. Indirect Labour Cost
DIRECT LABOUR COST | INDIRECT LABOUR COST |
It is DIRECTLY RELATED to: > Production of Units > Provision of service | It is NOT DIRECTLY RELATED to: > Production of Units > Provision of service |
Part of ‘Prime Cost’ | Part of Overheads |
e.g. > Worker directly involved in producing good > Worker directly giving service | e.g. > Supervision or > managerial work related to production and provision of service |
Direct wages is calculated on the basis of: > Basic Rate of Production hours (means basic rate shall be applied on normal hours worked i.e. 8 hours per day) > Overtime Premium (if specifically requested by the customer) | Indirect wages is paid for: > Overtime Premium (if it is NOT specifically requested by the customer) > Idle Time Hours (at Basic rate) > Bonus Payment |
In nut shell, every element of labour cost shall be indirect except Basic Rate of production hours and overtime premium if requested. | |
IDLE TIME
It is the payment made to a worker for more hours than he actually worked because he was unable to work due to any reason which was beyond his control.
Reasons beyond worker’s control
a. Machine break down
b. Stock out of Raw material
c. Training of worker
So the total amount paid to worker in this situation cannot be charged to actual unit produced because only some amount is related to produced units.
Formula for Idle time
Idle time = Actual hours paid – Productive Hours (Hours worked)
Productive Hours = Hours physically worked on the production line to produce a unit
Productive hours are also be actual hours because they show the actual hours worked.
Actual hours Paid = These are the hours for which payment is actually made but actual hours may be worked less than hours for which payment is made.
Example for Direct and Indirect Labour Cost
Standard Hours (Expected efficiency) = 10 units / hour
Actual Output (Actual units produced) = 450 units
Actual hours paid = 50 hours
Productive hours = 43 hours
Basic hours = 40 hours
Basic Rate = £8 / hours with 50% overtime premium
Bonus = 40% of the basic rate per hour saved
Solution:
Idle Time = Hours paid – Productive hours
= 50hours - 43 hours
= 7 hours
Standard hours for 450 units = 450 units / 10 units per hour
= 45 hours (required for 450units)
Direct L. Cost Indirect L. Cost
Basic Rate of Productive hours £ £
(Basic Rate x Productive hours)
(£8 x 43 hours) = 344
Basic Rate of Idle time Hours
[Basic rate x (Actual hours paid
– Productive hours)]
[£8 x (50 hours – 43 hours)] = 56
Overtime time Premium hours
[(Actual hours paid – Basic Hours) x
Overtime premium rate]
(50 hours – 40 hours) x (£8 x 0.5) = 40
Bonus
[(Standard hours – Actual hours) x
40% of Basic Rate per hour saved]
(45 hours – 43 hours) x (£8 x 0.40) = 6.40
= 344 102.40
Here the Actual Hours are Productive hours of 43.
LABOUR RATIOS
1. Efficiency Ratio
2. Capacity Ratio
3. Production Ratio
4. Labour Turnover
1. EFFICIENCY RATIO
Efficiency shows that how many hours labour taken in production line than expected hours. Efficiency is the relationship between the Input and Output.
Efficiency Ratio = Expected Time x 100
Actual Time
OR = Standard hours x 100
Actual Hours
OR = Actual Output in Standard hours x 100
Actual hours
2. CAPACITY UTILISATION RATIO
We have certain number of planned / budgeted hours and we want to know here that how many hours are worked productively out of planned hours. We check here that actual hours are more or less than planned. We have capacity constraint or we have limited hours to utilise. If we are less than budgeted hours, we have idle time.
Capacity Ratio = Hours spent on active work x 100
Total hours available
OR = Actual hours worked x 100
Budgeted hours
3. PRODUCTION VOLUME RATIO
It shows how many units have been produced in certain time (hours). We check here that units produced are less or more than expected.
Production Volume = Expected Time (hours) x 100
Total hours available
OR = Capacity Ratio x Efficiency Ratio
Example
There were 21 days of working hours at 8 hours / day with 10 workers.
Due to problems, there were 240 hours idle time.
Output was 5,400 units.
Standard time per unit is 15 minutes.
1. Total hours available = 21 days x 8 hour per day x 10 workers = 1,680 hours
2. Productive hours = Total hours available – Idle time hours
= 1,680 hours – 240 hours
= 1,440 hours
3. Expected hours (Standard hours) = Output in units / units produced in one standard hours
= 5,400 units / 4 units produced in one standard hour
= 1,350 hours (are expected to require to produce 5,400 hours)
I. Efficiency Ratio = Expected hours x 100
Actual hours
= 1,350 hours x 100
1,440 hours
= 93.75 %
II. Capacity Ratio = Hours spent on active work x 100
Total hours available
= 1,440 hours x 100
1,680 hours
= 85.71 %
III. Production Volume = Expected Time (hours) x 100
Total hours available
= 1,350 hours x 100
1,680 hours
= 80.36 %
OR
= Capacity Ratio x Efficiency Ratio
= 93.75 % x 85.71 %
= 80.35 %
4. LABOUR TURNOVER
Labour turnover is the number of people who are leaving the business.
Compliment – Number of Employees
Average Compliment – Average number of employees
Average number of employees – (Employees at the start and employees at end of year) / 2
Turnover – Amount of employees leaving and being replaced
Labour Turnover Ratio = Turnover x 100
Average Compliment
Example
A company employs 500 people at the beginning of the year and 600 people at the end of the year.
During the 50 employees left the company and has to be replaced.
Required: Labour turnover
Labour Turnover Ratio = Turnover x 100
Average Compliment
= 50 employees x 100
550 employees
= 9%
