Accounting for Labour

1 Introduction

This chapter looks at how remuneration is calculated and accounted for, and also how certain labour-related ratios can be calculated.

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.
  

The operation of a payroll system

A payroll system holds two kinds of information. Standing data changes rarely: the employee's name, bank details, pay rate, tax code, pension choice and department. Variable data changes every pay run: hours worked, overtime, piecework output, bonuses, sickness and holiday.

A pay run then works through the same sequence. Hours and output are collected from clock cards or time sheets and authorised by a supervisor. Gross pay is calculated from the standing data and the variable data. Deductions are calculated — employee income tax and statutory deductions — to give net pay. The employer's own payroll taxes are calculated on top. The payroll is reviewed and approved before payment, employees are paid the net amount, and the deductions plus the employer's contributions are paid over to the tax authority by the due date. Each employee receives a payslip showing gross pay, each deduction and net pay.

The controls matter because payroll is one of the easiest places to steal from. Starters and leavers should be notified in writing by human resources, never by the payroll clerk, so that a leaver cannot be kept on the payroll. Pay rate changes should be authorised outside the payroll department. Overtime should be approved before it is paid. Someone independent should compare this run's total with the last one and ask about any large change. And the payroll records must be kept for the period the tax authority requires.

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, the system is as follows:

Dr   Work-in-progress with the gross wages

Cr   Wages control account with the gross wages

Dr   Work-in progress with the employer’s payroll tax

Cr   Wages control account with the employer’s contributions to payroll tax

Dr   Wages control account

CR   Cash as employee paid the net amount

CR   Cash as the revenue authorities are paid employee deductions and employer contributions.

6 The relationship between payroll and production

It is common for manufacturing companies to pay on the basis of time worked, so clock cards showing total hours worked per week can be used as the basis of simple pay calculations. If the factory always produces the same product, then it is easy to trace the labour cost into the production cost.

Labour cost/unit = Total labour costs/total units produced.

If the factory produces several different types of unit (perhaps different units are made on different days), or makes individual products for customers (job or contract costing), then the factory will have to keep more detailed time records, showing exactly how long each person spend on each type of production.

The factory will also have to record separately details of production.

7 Utilisation, production volume and idle time ratios

When setting a labour budget it is normal to specify how long it should take to produce each item (standard hours/unit), how many units will be made and therefore how many hours the employees and the factory is expected to work.

For example, if each unit should take 2 hours to make and output is planned to be 5,000 units in a period, then the planned labour hours will be 10,000. This is also how long the factory should be working. Here, 10,000 is said to be the capacity of the factory ie what was expected to work.

A number of things can happen to these plans:

1. The units output might not take the standard hours per unit. This will give an assessment of efficiency.

2. More or fewer hours might be worked in the factory than originally expected. This will give an assessment of capacity.

3. More or fewer units might be produced than budgeted. This will give an assessment of production volume.

4. Although employees are being paid, they might be idle for a time (for example, if a machine broke down). It will be useful to quantify idle time.

Question

What does a production volume ratio of 120% say about the efficiency of workers?

A   Better than expected

B   Worse than expected

C   No conclusion can be drawn about worker efficiency

8 Labour turnover

Labour turnover measures the rate at which employees leave the company.

Generally, this rate should be kept low because:

• Cost of recruitment is high
  

• Cost of training is high
  

• Labour efficiency is likely to be low because new workers will usually not work as quickly as more experienced ones.
  

• Quality and customer satisfaction might be adversely affected.
  

• Work might have to be turned away because there isn’t enough staff
  

Of course, some businesses encourage a certain amount of labour turnover because new recruits are usually paid at a lower rate than more experienced ones.

It’s not hard to understand possible reasons for labour turnover. For example:

• Illness
  

• Employees want to move to get a variety of experience
  

• Dismissal
  

• Poor wages and conditions
  

• Too much stress
  

• Anti-social hours
  

• Poor opportunities for promotion
  

• Oppressive, unpleasant management
  

• Horrible job
  

• Broken promises
  

The labour turnover ratio is defined as: