Labour Costs and Remuneration Methods

1 Introduction

This chapter looks at how remuneration is calculated and accounted for.

2 Remuneration methods

Labour costs can arise from:

• Basic wage or salary
  

• Overtime premiums
  

• Bonuses
  

• Holiday pay
  

• Sick Pay
  

• Payroll taxes
  

Many countries pay wages and salaries under a ‘pay as you earn scheme’ which means that the employer deducts the employees’ income tax from the gross wage and pays that over directly to the tax authority. Only the net amount after tax is then paid to the employee.

Employee remuneration can be based on the following approaches:

1. A constant weekly or monthly amount

This is easy to calculate:

Labour cost = remuneration per period x number of periods

2. An amount based on hours worked (basis plus overtime)

3. An amount based on units produced: piecework

Often there is a guaranteed minimum amount of pay so as to comply with minimum wage rate legislation.

4. An amount based on productivity

There are many different types of bonus scheme and any question would have to set out the precise rules.

5. An initial amount plus a bonus

Here, for example, the bonus could be part of a profit share. Full instructions would have to be supplied as to how to calculate the amounts.

3 The effect of changes in remuneration methods and changes in productivity on unit labour costs

To increase competitiveness, employers will try to reduce unit costs and will often attempt to do this by offering employees productivity payments. Employers need to look at the before and after costs.

4 Gross and net earnings

• Gross pay: the total amount earned by the employee
  

• Net pay: the amount paid to the employee after the employer makes deduction for income tax and certain statutory amounts.
  

• Total labour cost to employer: employees’ gross pay plus any additional payroll taxes (and perhaps pension costs) that the employer has to bear.
  

5 Accounting for labour costs

In addition to being paid whilst working (basic, overtime premiums, productivity bonuses), employees are often also paid when:

• on holidays
  

• ill
  

• idle (because, say of machine breakdown)
  

The labour costs are classified as direct or indirect depending on what caused those costs:

Direct labour costs: all hours worked x normal hourly rate

Indirect labour costs: overtime premium, idle time, sick pay, holiday pay.

In double entry, gross wages are collected in the wages control account first and then split, so that the direct part reaches the units and the indirect part reaches the overhead:

Dr Wages control account with the gross wages and the employer's payroll tax

Cr Cash with the net pay to employees

Cr Payroll tax payable with the employees' deductions and the employer's contributions

…and then, to clear the wages control account:

Dr Work-in-progress with the DIRECT labour cost (hours worked on production at the basic rate)

Dr Production overhead with the INDIRECT labour cost (overtime premium, idle time, sick pay, holiday pay, and the wages of indirect workers)

Cr Wages control account with the total

The production overhead account is then absorbed into cost units in the normal way (chapter 9).

5.1 Idle time

Idle time is time that is paid for but not worked — a machine breakdown, a material shortage, a power cut. The hours are still paid at the basic rate, so they are still a cost; but they cannot be traced to any unit, so they are an indirect cost.

Idle time is usually measured as:

Idle time = hours paid – hours worked

5.2 Overtime premium

Overtime pay splits into two parts. The BASIC rate for the overtime hours is a direct cost, because those hours were spent making units. The PREMIUM — the extra above the basic rate — is an indirect cost, because it is caused by the factory being busy, not by the unit that happened to be made at 6 p.m.

The one exception: if a customer asks for their job to be rushed and agrees to pay for the overtime, the whole of the overtime, premium included, is a direct cost of that job.