Unit 2 (B) Labour Cost

Labour Cost (Ascertainment and Control)

Labour cost represent compensation in whatever form for human efforts representing human involvement and contribution to production process. Human resources or man power is the driving force that set all other factors of production in motion. This way it becomes the most important cost element as it can have a direct or even an indirect bearing on the performance of other factors/resources used in the production process. It is the second element in costing structure of a product after material.

according to Cost Accounting Standard - 7 (CAS-7) issued by ICMAI, employee cost is 'the aggregae of all kinds of consideration paid, payable and provision made for future payments, for the services rendered by employees of an enterprise 9including temporary, part time and contract employees).

The compensation or consideration include:
(i)Immediate monetary benefits: (a) Wages/Salaries (b) Dearness allowance (c) Production bonus
(ii) Deferred monetary benefits; (a) EPF contribution, (b) ESI payments (c) Retirement benefits
      (d) Profit bonus
(iii) Fringe benefits: (a) Free or subsidized housing, canteen etc. (ii) Provision of car, cell phone etc

Labour costs can be classified as direct or indirect labour cost.

Direct labour cost represent labour costs incurred on employees/workers engaged directly in main production process or core business activity. This labour cost is directly responsible for converting raw material into finished goods. Direct labour compensates for the time and efforts consumed in making the product. Direct costs can be logically and conveniently attributed or allocated or charged to the production process. In other words it can also be said that production process or rendering of the main service is not possible at all without such labour costs. In a manufacturing unit, wages paid to machine operator or wages paid to a carpenter in a furniture unit or wages to a mason in construction unit are examples of direct labour.

Indirect labour is the residual labour cost i.e. compensation of human efforts and time not directly related to the production process but bears an indirect relation. In fact it represents a support or facilitating function. Think of accounts clerk, watchman, peons, cleaners, legal counsels, general manager, supervisors, instructors, trainers, etc. Wages and salary paid to such personnel are not direct but they are in support role i.e. related indirectly. Another test is that their full time and engagement is not linked to the production process or service, hence it is not justified to charge full wages or salary to the production process under question. This poses an inconvenience of apportioning such costs so that only that portion of labour cost which can be linked to the production process is charged to the production process. For example if general manager devoted only 40 hours out of his total 160 hours to manufacture process. Under this situation only one fourth of his salary shall be apportioned and charged to the production process.

Labour cost is distinct from material cost on following counts:

i)   Material is an object while labour is a subject

ii)  Labour is human involvement which is influenced by its own aspirations, emotions etc.

iii) Material is a physical asset, has future value and can be stocked and disposed off in future at profit in case of rising prices. This is not so with labour, it can’t be stored i.e. a day’s labour has to be utilized in that day and if not utilized, it is wasted as it is linked to time.

iv) Labour output is most of the time linked to its efficiency which is irrelevant in case of materials

v)  In case of service industries, it is the main cost component. In case of Non-service industries also, if not prime component, even then it is significant and cannot be taken casually.

      It is to also to be understood that labour costs include both monetary payments and Non-monetary benefits. Examples of monetary benefits include: (i) Basic Wages (ii) DA (iii) Production or profit bonus (iv) ESI/PF benefits (v) Gratuity (vii) Pension (viii) Holiday pay (ix) Allowances (x) Commissions

 
      Non-monetary benefits include: (i) Recreation facilities (ii) Medical & Health facilities (iii) Canteen, free or subsidized (iv) Educational facilities to children of employees (v) Training and development programmes (vi) Housing facilities (vii) other free benefits like car, cell phone etc.

Further, while ascertaining labour costs following points need consideration:

The following items are to be ‘included’ for the purpose of measuring employee cost:

(i) Any payment made to an employee either in cash or kind

(ii) Gross payments including all allowances payable and includes all benefits

(iii) Bonus, ex-gratia, sharing of surplus, remuneration payable to Managerial personnel including Executive Directors and other officers

(iv) Any amount of amortization arising out of voluntary retirement, retrenchment, termination, etc

(v) Variance in employee payments/costs, due to normal reasons (if standard costing system is followed)

(vi) Any perquisites provided to an employee by the employer

The following items are to be ‘excluded’ for the purpose of measuring employee cost:

(i) Remuneration paid to Non-Executive Director

(ii) Cost of idle time [ = Hours spent as idle time x hourly rate]

(iii) Variance in employee payments/costs, due to abnormal reasons ( if standard costing system is followed)

(iv) Any abnormal payment to an employee – which are material and quantifiable

(v) Penalties, damages paid to statutory authorities or third parties

(vi) Recoveries from employees towards benefits provided – this should be adjusted/reduced from the employee cost

(vii) Cost related to labour turnover – recruitment cost, training cost and etc

(viii) Unamortized amount related to discontinued operations.

Matters or factors that affect labour cost:

1.       Production planning

2.       Standards of performance

3.       Labour budgeting

4.       Wage policy including promotion, transfer, retirement benefits, leave policy etc.

5.       Performance appraisals and resultant response actions.

6.       Government regulations.

Labour cost or labour bill is composed of (i) no. of workers, (ii) attendance i.e.time (iii) rate of wages/salary

In order to efficiently control above factors, Labour control is organized generally under:
(a) Personnel department
(b) Engineering department
(c) Time keeping department
(d) Payroll department
(e) Cost accounting department

Personnel Department: It is the department entrusted with management of all issues related to man power or human work force from lowest to highest level. General functions include:

1.       Assessing man power requirements

2.       Enlisting sources of supply of man power

3.       Selection, appointment, Training, placement and orientation
4.    Training and Development

4.       Performance appraisal, increments, promotions, transfers.

5.       Sometimes payroll department functions as a subsystem of HR department

6.       Wage policy including incentives

7.       Industrial relations

8.       Suspension, Terminations, Retirements

9.       Welfare measures.

10.   Personnel services.

Can you visualize few qualities an HR manager should possess after looking at above functions expected from HR department?

Two important aspects in personnel management are Job evaluation and Merit rating.

Job evaluation and Merit Rating

Many a times a worker say a clerk complains that he actually does all the work, spent more time and face all types of music associated with the job, yet, the salary of general manager is many times higher than his. Another scenario is that two workers getting same salary even when one is irregular, careless and less hard working. Then there are other issues like promotion, increments etc. which also make an employee think on these questions. However, these are even bigger questions for owners and managers as to how to devise a wage system that is just and equitable and fairly compensates a worker for his efforts. Job evaluation and merit rating seek to provide solutions to these issues,

Job evaluation is the process of assessing the intrinsic and extrinsic worth of the job. In other words, how much important is the successful execution of that job for the organizational goals. If we think of human body, it is a general understanding that heart and brain play the most vital role than say bones or stomach.

Likewise, in commercial organization one job may be more vital or important than remaining others and so on. This follows next consideration i.e. that successful execution of a job may require different attributes like qualification level, skill sets, continuous training, responsibility burden and so on. It is obvious that a CEO carries much higher responsibility burden than an accounts clerk.

Based on above ideology Job Evaluation carries out the ranking, grading and weighting of essential work-characteristics comprised in a job and putting a monetary value to it.

Job evaluation methods include: (i) Ranking method (ii) Point Ranking method (iii) Grading method.

Thus main objectives of job evaluation are :

(a)developing a systematic and rational wage structure as well as job structure.
(b)removing the controversies and disputes relating to salary between the employers and
employers and employees.
(c) bringing fairness and stability in the wage and salary structure so as to ensure full cooperation of workers in implementing various policies of the employers.
(d) highlighting characteristics and conditions relating to different jobs. This ensures right man on right job.

Merit Rating: Merit rating is looking the problem from the side of employee i.e. how suitable or fit is an employee for a job based on his qualification, training, experience, personal qualities etc. The Merit Rating aims at evaluation and ranking the individual employees
in order to plan and implement rational promotional policies in the organization. 

Ojectives:-
(a) To evaluate the merit of an employee for the purpose of promotion, increment, reward and other
benefits.
(b) To establish and develop a wage system and incentive scheme.
(c) To determine the suitability of an employee for a particular job.
(d) To analyze the merits or limitations of a worker and help him to develop his capability and
competence for a job.
(e) To examine characteristics like cooperation, quality of work done, attendance and regularity, education, skill, experience, character and integrity and initiative.

Thus it can be understood that Merit Rating is extremely useful for organizations for evaluating the
employees. However the main limitations are that the rating can be subjective which will give rise to
the disputes and there is a possibility that past performance of an employee may be given too much
importance.

Difference between Merit Rating and Job Evaluation

The difference between the Merit Rating and Job Evaluation are as follows:-
(a) Job Evaluation is the assessment of the relative worth of jobs within a business enterprise and Merit
Rating is the assessment of the employees with respect to a job.

(b) Job Evaluation helps in establishing a rational wage and salary structure. On the other hand, Merit
Rating helps in fixing fair wages for each worker in terms of his competence and performance.

(c) Job Evaluation brings uniformity in wages and salaries while Merit Rating aims at providing a fair
rate of pay for different workers on the basis of their performance.

Engineering and Work Study Department: This department lays down the exact methods, procedures and prescriptions for carrying out a work. Generally, it

(i)                  Identifies the Work/task, prescribe specifications with respect to quality and time limits.

(ii)                Analysis of each job with respect to methods, motion and time study.

(iii)               Prepares and communicates operations schedule laying down the list and sequence of labour Jobs/steps/processes/operations with required ingredients specifically man power requirement and including material and machines necessary for each.

(iv)               Suggests and prescribe necessary working conditions, facilities, safety measures etc.

(v)                Prescribes wage rates, incentive plans, time-rate and piece rate wage structures

(vi)               Prepares financial budget of labour cost for the work/operation.

Work Study :

Methods Study: it studies and prescribes improved methods of production by which the existing resources may be best and effectively utilized. This is done by observing and analyzing the job or the process into operation elements, eliminate unnecessary and wasteful operations, arrange the desired operations into orderly sequence, allocate the work to the right type of workers, and develop new and improved methods which are easy to operate.

Motion Study: It tries to find out and prescribe the best way of doing a job i.e. by identifying and eliminating wrong, redundant and tiresome motions.

Time Study or Work Measurement determines the time required to perform the job by an operator of an average skill and training, working under normal conditions and with an average effort.

As the efficiency and skills level of workers may be different i.e one worker may be exceptionally fast while other may be a bit slow, thus, while carrying out time study an averaging is done to arrive at the normal or standard work time.

Normal time for completing a work: Time taken X (Rating/Base or Normal Rating)

(here rating is given or arrived at by using Performance Rating Tables and applied to a worker suggesting his efficiency or level of working in comparison to Normalized working levels of a normal/average worker)

TIME KEEPING DEPARTMENT
Number of workers, their attendance and time spent or devoted on a job is recorded by Time Keeping department. This is a very sensitive function as the amount of labour cost is directly affected by all above factors. Methods for recording attendance and time spent include
(i) Time card or clock machines (ii)Disc method (iii) Manual attendance registers (iv) Bio-metric attendance machines
Time keeping is very important aspect in labour cost control due to: (i) if the attendance is not correct, wrong payments of wages will be the result. If it is more, it is a loss to employer and if it is less, it is a loss of employee. Either way, this leads to dissatisfaction and rift and if left unresolved, it ultimately leads to loss of productivity. (ii) Correct costing of a job or production run (iii) meeting various statutory requirements.
Time Booking : Time booking records the time devoted by an employee on various jobs i.e. start time, end time, efficiency level etc. Methods include: (i) Daily/Weekly Time sheets (ii) Job Card

Wage Systems: A wage system provides the mechanism to compensate the human efforts. It should be just and equitable to the workers as well as the employer organization. It should cater to the aspirations of the employees and maintain the productivity of human resources.

Since long, wage systems relate either to time spent by the worker on the job or the level of output or quantum of work accomplished. This is represented by (i) Time rate system (ii) Piece rate system. Then, there are combinations of these two systems and further there are incentive plans based on level of performances etc.

Major wage systems are listed  below:

(i) Time rate 

(ii) Piece rate

(iii) Incentive plans
      
      --for individual workers: Incentive may either be based on time saved or on the basis of increased production. Time saved basis incentive plans include: (i) Halsey plan (ii) Halsey-weir plan (iii) Rowan Plan (iv) Emerson efficiency plan (v) Beadaux point system
       
       Incentives based on level of production include: (a) Taylor's differential piece rate system (b) Merrick's plan (c) Gantt's task bonus plan

        --Incentive plans for group of workers
           (i)  Profit sharing 
           (ii) Co-ownership
           (iii) Scanlon plan
           (iv) Priestman plan

Indirect or administrative workers are given incentives mainly by way of Group incentive schemes, profit sharing, ESOP's, 

Problem: ‘A’ worker takes 22, 20, 21 minutes in the performance of an operation, on three counts and his rating has been found to be 70/60 with the help of Performance Rating Table. Another worker ‘B’ takes 25, 26, 24 minutes on the same operation on three counts and his rating is 50/60. Allowances for fatigue, personal needs etc. is determined as 20%. Calculate the Standard or Normal time for the operation.

Ans: 27.20 minutes.

Problem 2: A work measurement study done in a company for 9 hours in a day revealed the following:

Units produced:     36

Idle Time:                10%

Performance rating:  72/60

Fatigue allowance Time: 10% of Normal time

Calculate standard Time for the work

Ans: 17.82 or 18.00 minutes.

Payroll Department
Roll of Payroll Department is of crucial importance in overall Labour Cost computation and control. The
main responsibilities of this department are preparation of payroll from clock cards, job or time tickets,
or time sheet. The payroll shows the amount of wages payable to each worker showing the gross wages
payable, the deductions and the net wages payable. For doing this calculation, they have to work
in collaboration with the time office, personnel department, Cost Accounting department and with
the concerned department in which the worker is working. The functions of this department are given
below:-
(a) To compute the wages of the employees
(b) To prepare a detailed wages sheet showing the gross wages payable, various deductions and
other payroll liabilities.
(c) To maintain individual employee payroll records.
(d) To prepare department wise summaries of wages.
(e) Compilation of Labour statistics for management.
(f) To install and implement an effective internal check system for preventing frauds and irregularities
in payment of wages.
(g) To detect and prevent ghost workers.

Note: Various items that have a monetary bearing on the final wage bill include: deductions on account of (i) TDS (ii) EPF and ESI (iii) Recovery of Advances (iv) recovery for amenities like house rent, electricity bill, (v)penalties etc. Likewise there may be extra payments on account of (i)overtime, (ii)bonus, (iii)rewards (iv) arrears of salary (v) commission

Cost Accounting Department
The Cost Accounting department is responsible for analyzing the Labour Cost for the purpose of
computation and control of the same. It is responsible for the accumulation and classification of all
cost data of which Labour Cost is one of the important components. The Cost Accounting department
classifies the Labour Cost into direct and indirect, compares the actual Labour Cost with the budgeted
cost, compute unit Labour Cost and compiles the data for further analysis of the Labour Cost. The data
generated can be useful for the management in taking decisions.



There are few common issues affecting either labour cost amount directly or indirectly affecting productivity. These are (i) Labour Turnover (ii) Idle Time (iii) Overtime


Labour Turnover: Simply put labour turnover means the rate at which existing employees leave and new employee join an organisation with in a given time period. A higher labour turnover indicates that employee frequently leave the job and new employees are appointed in lieu. If this is a routine feature, then it has adverse impact on the productivity and thus costing.

Adverse effects of high labour turnover include:
(i) higher costs for arranging new workers.
(ii) higher training costs
(iii) reduced production as new workers are not as efficient as trained employees.
(iv) increased wastage, idle time, supervision, machinery breakdown etc.
(v) loosing completion deadlines.
(v) strained employer-employee relations.


Causes of Labour Turnover: Avoidable and Unavoidable
Avoidable causes include:
(i) Poor working conditions
(ii) Delay in payment of wages and other benefits.
(iii) Weak statutory compliances.
(iv) Lack of essential or necessary facilities like rest-rooms, transport, security, cleanliness etc.

Unavoidable causes include:
(i) Nature of work is risky for life.
(ii) Work place is remote.
(iii) Lack of support facilities like hospitals, schools, banks, post-office, police station etc.
(iv) Extreme climate
(v) Seasonal industries 

Formulae for calculating labour turnover:
(i) Separation method : (No. of workers left/ average no. of worker) X 100

(ii) Accession method (or replacement method): (No. of worker joining / av. no. of workers) X 100

(iii) Flux method : {(total workers leaving + total workers replaced)/av.no. of workers} X 100           


Labour Turnover, to some extent is normal and unavoidable, but beyond that level it has costs and which can be serious. Thus management should try to keep labour turnover at minimum.
Costs associated with labour turnover can be grouped under two categories:
(i) Preventive Costs, and (ii) Replacement costs

Preventive costs of labour turnover include:
 (i) Costs of welfare, subsidized canteen, sports facilities, training and development 
(ii) Security measures like pension and gratuity, 
(iii) Fringe benefits like furnished accommodation, free transportation, club membership, excursion tours etc. 
(iv) Supportive HR department
(v) Rewards and recognitions

These are known as preventive costs as they prevent an employee from leaving the job i.e. act as a deterrent. 

Replacement costs of labour turnover include:
(i) Cost of recruitment
(ii) Cost of induction and training
(iii) Cost of breakdowns, spoilage, defectives and reduced production.
(iv) Cost of not meeting supply dead lines due to delayed production runs.
(v) High costs of supervision
(vi) Loss of goodwill


Idle Time: It is the time during which worker does no work but for which payment of wages/salary has to be made. It is equal to excess of time paid over time booked. This may be normal and unavoidable) or abnormal and avoidable). Always remember that abnormal or avoidable idle time is a real cost which should be kept at minimum possible. 

Avoidable idle time results from: Non-availability of material or machine, Faulty or defective material, worn-out or unfit tools, machinery breakdowns, power failure, labour unrest, strikes-lockouts, Wrong process or work flow, Lack of co-ordination between departments where output of one is output of second and so on. 

Unavoidable idle time may result on account of war, riots, flood, earthquakes etc.

There may be cases of disguised idle-time i.e. a situation where a worker does the work slower than normal. He is busy all the time yet output is less. This way he is able to get extra wages for the same work.

Accounting treatment of idle time: Normal idle time is charged to the production by way of payment even for the time during which worker remained idle. Abnormal idle time should be charged to costing profit and loss account and should not be charged to production account.

Control of Idle time: Causes and magnitude of idle time should be recorded along with the reason or cause or responsible person. Impact of idle time in money terms should also be mentioned. 


Overtime: It is work done beyond normal working hours. Overtime is extra time devoted by worker on production process during the course of day. It is necessitated if there are dead lines, extra sales orders or sales orders on urgent basis. 
       Avoidable overtime for example workers knowingly working slowly during normal working hours in a bid to get extra wages in the form of overtime, should be avoided as it is an unnecessary cost. It should be kept in mind that normally overtime wage rate is double the rate of normal working hours.
       
      Overtime is not a preferred practice on account of :
       (i) Increased cost as the wage rate is twice the normal wage rate.
       (ii) Overstresses the worker and normal working of fatigued employee is affected .
       (iii) Unscrupulous workers tend to idle away the normal working hours and work only during over time sessions.
       (iv) Overtime also increases the cost of support services as during overtime other facilities have also to be kept open, for example, repair and maintenance, lighting, heating, air-conditioning etc.

       Overtime at the insistence of the customer, say may be on account of some emergency, should be charged to production. This is because, such a production run or job is peculiar or special to that customer only. Other jobs proceed as per normal working hours schedule.

       Overtime on account of general production schedule should be treated as an overhead i.e. indirect expenses.

           Abnormal overtime i.e. which should not have occured, had things took place on a normal basis should always be charged to costing profit and loss account. Eg. Overtime to cover earlier loss of time, Overtime due to wrong production schedule etc.
     

       Special types of workers:

1. Dummy (Ghost) workers: They are not real workers. They may or may not exist even as a human being, I.e only name may be enrolled as a worker in HR and payroll. They are fake workers. Unscrupulous personnel may use this gimmick to syphon funds.

  Proper identity records and physical verification by reporting head or senior may check such activity.

2. Casual workers: they are irregular workers nd and are called to work as and when required. Generally they are called to replace absent regular workers or to meet additional work load.

They should be called under proper authority and proper record of their joining, work done and Date of leaving should Be maintained. Two different persons should be assigned to monitor their working and wage payment.

3. Out workers: Some times workers have to work at some other place as special jobs or assignments. Eg. Different construction sites or members of a software implementation team working at client's site etc. In such cases routine attendance is not feasible. Another category of workers work from their own place that is. Say their home.

4. Outside workers: Where a part of work or process is done by labour by supplying them the raw material and or work in progress and they work from their home or own place. After completion of work they return the goods so worked upon to the factory unit. Here, control over output and time limits are important as method of piece rate is mainly governed by piece rate method. There may be penalties for late work or incentives for completing work within or before time limits.