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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
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LESSON# 11
LABOR
There are three elements of cost:
Material
Labor
FOH
Labor costs constitute an important part of production cost. Labor cost is and element of total
payroll expense of an entity. Payroll expense consists of:
Labor cost
Administrative staff expenses
Selling and distribution staff expenses
The total labor cost incurred by a manufacturing entity includes four separate elements:
Direct labor cost (this is expensed on production and it is traceable in the cost unit)
Indirect labor cost (this is also expensed on production but it is not traceable in the cost
unit)
Abnormal labor cost (this is the labor cost that is lost because of break-down of power and
machinery etc.)
Labor related cost (this includes overtime pay, bonus pay, shift allowances, and other
benefits)
From the cost and management accounting point of view, the distinction between direct labor
cost and indirect labor cost is very essential.
Direct Labor Cost
Direct labor cost is that portion of salaries and wages which can, as a practical matter, e traced
with and charged to a cost unit. Thus the wages paid to employees/workers engaged in
manufacturing of a job or process like bricks, spinning and weaving, are direct labor cost.
Broadly speaking, labor costs will be direct if:
a.
There is a direct relationship to the product through a process,
b.
The labor cost can be measured in the light of this relationship, and
c.
The labor cost is sufficiently material (significant) in amount.
However, the main criterion of determining the direct labor cost is that if it is economically and
conveniently be identified /traced with a product, it is a direct labor cost.
Indirect Labor Cost
These are the costs which are not identifiable with or incurred directly in the production of a
specific goods or services but are applicable to manufacturing activities generally, salaries and
wages paid to supervisors, foremen, storekeepers, clerical staff member will constitute the
indirect labor costs. Mostly costs of service departments, supervisory and engineering
departments are indirect labor costs.
Salaries & Wages
Salary is a fixed amount of remuneration paid to the employees after a month or a year.
Wage is remuneration of the employees/workers who work on hourly or unit produced basis.
Determining Wage Rates
Wage rates are determined on the basis of requirements of a job. Job analysis is breaking up of a
job into basic elements or operations and studying them in detail to find out the duties,
responsibilities and skills involved in it.
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It is a process of determining the contents and characteristics of a job, the conditions under
which performance is to be carried on, the qualifications required in the worker, methods and
techniques used and other conditions and skills involved. This basic object of job analysis is to
ascertain the relative worth of each job through an objective evaluation so that suitable
remuneration can be fixed for each Job and worker.
Advantages of Job Analysis
a.
Job analysis facilitates selection of right type of workers according to the job
requirements. It helps in training the workers accordingly.
b.
Job analysis helps in fixing suitable wage rates for different jobs according to their
characteristics, skills required and hazards involved.
c.
It helps in Job evaluation and merit rating thereby improving the decision making
ability of the supervisory staff in regard to transfer, promotion and placement.
d.
Job analysis facilitates the settlement of disputes with workers in regard to duties-
wages, transfer and other disciplinary action by providing complete requirements of different
jobs.
e.
It helps in placing employees on the most suited jobs and thus increasing their
satisfaction and morale. It helps in reducing labor turnover, absenteeism and removes inequ-
alities in wages and salaries.
Time-Keeping
In an industrial enterprise accurate time keeping is very essential, normally, recording of time is
done for two purposes:
a.
For administrative and payroll purposes, and
b.
For cost analysis and apportionment of overhead among different departments.
Wages to casual and temporary workers are paid on time basis while others are paid on piece
rates with minimum guaranteed wages. Payment of wages to such categories of workers is
dependent on the proper recording of total time spent by a worker in the factory and on the Job.
Purposes of Time-Keeping
Recording of time is essential for the following purposes:
a.
Preparation of Pay Rolls, where the workers are paid on time basis.
b.
.Meeting the statutory requirements.
c.
For internal administration, like increments, pension, provident fund, gratuity and leave
benefits.
d.
For proper distinction between direct and indirect costs, normal time and overtime,
and regular and late comers.
e.
For overhead rates, if based on labor hours.
f.
For enforcing regularity, discipline and ensuring daily requirement of labor force in the
factory.
Methods of Time-keeping or Recording:
Following are the usual methods of recording attendance of workers at the gate of a factory.
1)Manual Methods:
A. Attendance Register, and
B. Token system
2)  Mechanical Methods:
A. Time recording clock, and
B. Dial Time Recorders
3)  Electronic Methods:
A. Smart card
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Manual Methods
Attendance Register method (Hand written record):
Under the method a register with necessary columns like name, identity no. of the employee and
arrival and departure time is maintained.
In a large factory, separate registers may be maintained for each department but in a small
factory one register may serve the needs of the entire factory.
The practice of recording attendance or roll calls may conveniently be adopted depending upon
the nature of employees and their number. As soon as a worker enters into the premises of the
factory the necessary entries in the attendance register are completed either by calling the name
of each worker or by some other physical method.
Disk or Token or Check method:
Under this method each worker is allotted a metal disk or token bearing his identification. On
each disk the name and number of the worker is engraved or painted. All the tokens or disks are
hung on a board serially note the arrival time of the workers.
As soon as a worker reports for duty on the appointed time he/she removes his/her disk from
the board and puts into a box. Immediately after the scheduled time for entering into the
premises of the factory the board is removed and a list is prepared of all such disks or tokens not
collected and dropped into the box by the workers. The late comers collect their disks and hand
over personally to the time keeper. The list of late comers is prepared separately. The tokens not
removed from the boards represent the absentee workers.
Mechanical Methods
Different mechanical devices have been designed for recording the exact time of the workers.
These include:
a. Clock Card
b.Dial Time Records.
Clock Card
The attendance of workers in this system is marked by a time recording clock on a card each
worker is given a clock card usually for one week duration. These clock cards are serially arranged
and kept in a tray at the gate of the factory and as the worker enters into the gate he picks up
his/her clock card from the tray, puts it in the time recording clock that records the exact arrival
time at the space provided on the card against the particular day.
This process is repeated where the worker leaves the factory after his/her day's work. Other
particulars of time in respect of lunch, late arrivals, early leaving and overtime are printed in red
so as to distinguish these from normal period spent in the factory. This is very popular method
of recording the attendance of workers. The format of clock card is given below:
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FUTURE SHINE CO. LTD
Clock Card
Worker's Name____________ Department ___________ Token # ___________
Week______________
Days
Time
Regular-time
Over-time
Total-time
In
Out
In
Out
Normal
Over-
time
time
Monday
A.M.
P.M.
Tuesday
A.M.
P.M.
Wednesday
A.M.
P.M.
Thursday
A.M.
P.M.
Friday
A.M.
P.M.
Saturday
A.M.
P.M.
Sunday
A.M.
P.M.
Calculations of
Normal
Over-
Rate
Amount
Deductions
Net
i
Hours
payable
Worked
Time keeper____________ Foreman_______________ Payroll Clerk ______________
Worker____________
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Electronic Methods
In the era of Information Technology wastage of time is considered as a sin. Although manual
and mechanical methods produce accurate results but both are time consuming methods. Same
results with less time consumption and lesser chance of errors can be obtained with the
application of electronic devices. Now a days clock cards have been substituted with the smart
cards.
Smart Card
Clock cards may be replaced by smart cards. These record the same information, but it is
recorded on the magnetic strip on the card. Smart cards may also be used for other purposes not
related to the payroll.
Job Time Sheets
For proper labor cost analysis, it is essential that the worker records, in details, his/her activities
of production and time he/she spends on each job correctly. Time spent by a worker on the job,
process or activity may be recorded manually, mechanically or electronically depending upon the
nature and size of the enterprise. Recording of time spent by the worker on the job is better
known as time booking. The objects of time booking are:
1.
To ensure that the time paid for is properly utilized.
2.
To ascertain the labor cost for each individual job and the cost of work done
3.
To determine the rate of absorption of overhead expenses based on direct labor and
machine hour methods against each job.
4.
To ascertain and minimize idle time.
5.
To evaluate each employee's performance by comparing the actual time taken with the
budgeted time.
For achieving these objectives it is very important that clear instructions should be issued and
proper forms are designed for recording work time.
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FUTURE SHINE CO. LTD.
Daily Time Sheet
Worker's Name____________ Department ___________ Token # ___________
Date______________
Job or
Work
Descriptio
Time
Total Hours
Cost
work
done
n of work
order.
On
Off
Ordin
Overti
Rate
Amount
Total hours_____________
Workers______________
Total cost_______________
Fore man____________
PAYROLL SYSTEM
The payroll is a list of the employees of the organization and the money due to each. A payroll
list is produced each time that employees are paid.
Wage earners are paid weekly.
 Salary earners are paid monthly.
Sometimes, employees earn a fixed amount every week or every month. Sometimes there are
variations in the amount employees earn, due to overtime payments or bonuses or commissions
which add to their pay.
GROSS PAY AND NET PAY
DEDUCTIONS
The total amount earned in a week or month by an employee is called his or her gross pay.
This is not the amount of money that the employee receives, because deductions are taken away
from the gross pay, and the employee receives just the gross pay less deductions. This is known
as the employee's net pay.
The deductions from pay are usually a combination of:
 Statutory deductions and
 Non-statutory or voluntary deductions.
Statutory deductions are deductions from pay that are made by law. In the Pakistan income tax
is taken away from gross pay and paid to Income Tax Department, which is the main tax-
collecting department of the government.
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Income tax is collected from employees every time they are paid, and this system of tax
payment is therefore known as Pay As You Earn or PAYE. An employer is required by law to
deduct income tax from the wages and salaries of all their employees.
The employer in effect acts as an unpaid tax collection agent for Income Tax Department.
Non-statutory deductions are voluntary deductions from pay that the employee chooses
to make. Examples of these are:
Subscriptions to a trade union
 Contributions by the employee to a pension scheme.
Rupees
Gross pay
***
Less:
Statutory deductions
(***)
Non-statutory deductions
(***)
Net pay or take home" pay
***
What this means is that when an employee is paid, he or she receives the net pay or take home
pay, and the employer pays the other amounts to other organisations ('external agencies') such as
Income Tax Department, a trade union and a pension scheme organisation.
COST OF LABOR TO THE EMPLOYER
Although the employee only receives the net pay, all the deductions have to be paid to other
organisations, and it is the employer who has to pay them. Therefore, you might think that the
total cost of wages and salaries to the employer is the total of gross wages. In fact the total cost
of wages and salaries to an employer is higher than the total gross wages and salaries. This is
because there are two elements in Provident Fund Contributions.
There are employees' provident fund contributions. These are a part of the statutory
deductions from gross pay,
There are also employer's provident fund contributions. These are additional payments that
the employer has to pay the government.
The amount payable is related to the amount earned by the employees, but it is nevertheless an
additional labor cost for the employer.
To an employer, the total cost of wages and salaries is therefore:
Gross wages and salaries, plus
Employer's provident fund contributions.
OTHER DEDUCTIONS
The employer and employee may agree that other deductions should be made from the
employee's salary. Examples are:
(a) Pension contributions.
(b) Deductions under the payroll giving scheme (charity giving).
(c) Deductions under a payroll savings scheme,
(d) Trade Union subscriptions.
(e) Deductions under Holiday Pay schemes,
(f)  Certain other voluntary deductions agreed by the employer (for example, fees for use of the
company sports club).
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PRACTICE QUESTION
The following figures have been extracted from a trader's records in respect of wages and salaries
for July.
Rupees
(i)  Wages and salaries (gross)
6,300
(ii) Income tax
1,600
(iii) Employees' pension contributions
600
(iv) Employer's pension contributions
700
1
What is the total amount the trader will have to pay for wages and salaries for July?
A
4,100
B
4,800
C
6,300
D
7,000
2
What is the net pay received by employees?
A
4,100
B
4,200
C
4,800
D
5,600
PROCESSING THE PAYROLL
To process the payroll, an employer must, for each employee:
Calculate the gross wage or salary for the period.
1.
Calculate the income tax payable out of these earnings.
2.
Calculate the employee's state benefit contributions that are deductible.
3.
Calculate the employer's state benefit contributions. For all employees collectively,
4.
the employer must:
Calculate any non-statutory deductions.
5.
Prepare a payslip showing the gross pay, deductions and net pay.
6.
Make the payment of net pay to the employee.
7.
Make the payments of all the deductions from pay and the employer's state benefit
8.
contributions to the appropriate other organisations.
Record the payroll costs in the accounting system.
9.
PAYSLIPS
A payslip will accompany each payment of salary or wages to an employee. It shows how the
amount paid has been arrived at, how much income tax and state benefit contributions has been
deducted. The provision of a payslip detailing the income tax and provident deductions is
another responsibility of an employer as required by the national law. Other deductions will also
be shown on the payslip.
Getting a payslip means that even if the employee receives wages or salary payments directly into
his bank account, he is notified of the payment and how much it is by receiving the payslips,
Payslips might be distributed to employees at work, or posted to their home address.
A payslip must show details of:
Gross pay
Deductions (itemized separately)
Net pay (Net pay is sometimes called 'take home pay').
However, there isn't a standard layout for a payslip and so payslips of different employers can
look very different.
An example is shown below.
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Silver Glass Manufacturers
PAYSLIP
Employee: Syed Imam Din
Employee #. 256
National Tax Number:
Social
Date: 08-10-
Tax period:
7296849-5
Security:  Y
06
week 40
45
Pay For Week Ending:
Hou  Rate
Amount Rs.
Year To Date
October 8th.
rs
Rs.
Rs.
Basic Pay
40.0
7.50
300.00
Overtime
5.0
15.00
75.00
Shift Allowance
2
10.00
20.00
Gross Pay
395.00
Pension (Employer's pension
15.00
contribution Rs.25.00)
Trade union subscription
10.00
Total Pay
370.00
16,605.00
Income Tax
57.92
2.711.32
Provident Fund (Employer's Cont
30.85
Rs.36,71)
NET PAY
281.23
Content of the Payslip
A payslip must show certain items, by law. Compulsory items in the UK are:
The employer's name
The employee's name
The date
The total gross pay, showing the calculation where it comprises different elements
such as bonuses, overtime etc
The employee's pension contribution (if there is any)
Other deductions from, or adjustments to, pay. If a set amount is deducted each pay
day the breakdown need not be shown, provided the employee was given the details earlier
Total gross pay to date for PAYE purposes
Total tax paid to date in the current tax year and tax due this pay day
National Insurance contributions due this pay day
Net pay.
The payslip may also show additional information (and often does), such as:
the employee's Payroll Number
the employee's Social Security Number
the employee's National Tax Number
the total provident fund contributions paid by the employee in the tax year to date
the method of payment, such as `paid through cheque or cash etc.'
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employer's provident fund contribution for the current period
employer's provident fund contribution for the tax year to date
MAKING PAYMENTS TO EMPLOYEES
Most employers will have a set day on which employees should be paid, and it is the payroll
department's responsibility to ensure that wages are paid on the correct due days.
Weekly paid employees will be paid at least once a week, normally on the same day each week.
Usually the pay day will be either Thursday or Friday.
Monthly paid employees will be paid once a month, and there will be a formula for determining
the pay day. For example, this may be:
the last day of the calendar month
the last Friday or Saturday of the calendar month
the same date each month, such as the 26th.
Employees may be paid their wages in several ways:
in cash (but this is now very uncommon)
by cheque
by bank transfer
through the Banks Automated Clearing System (BACS).
PRACTICE QUESTIONS
1
Which of the following does not appear on a payslip?
A.
Gross weekly wage for the employee
B.
Tax paid to date by the employee in the tax year
C.
Deductions paid by the employee
D.
Details of the employee's expected pension.
2
Which is the most convenient way for a large employer to pay salaries electronically?
A.
BACS
B.
Bank transfer
C.
By cash
D.
By cheque.
Elements of Gross Pay
The amount of pay to which an employee is entitled may be earned in a variety of different ways.
These include:
(A) Basic pay, such as:
a. wages paid according to the number of hours worked
b. Wages paid according to the output of the employee.
c. salaries, for salaried staff
(B) Other pay, such as:
a. overtime pay, for extra hours worked by the employee
b. shift pay, to compensate for unsocial hours.
(C) Bonuses and commission, such as:
a.  bonuses paid under bonus schemes, based on productivity, or profitability
b.  commission paid, normally based on sales.
Rupees
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Basic Pay
****
+ Bonus
****
+Overtime payment
****
+Other allowance
****
Gross pay
****
-Statutory deduction
(***)
-Non Statutory deduction
(***)
Net Pay
****
Payroll Entries
Payroll Preparation
Payroll expenses
100
Deduction of income tax
5
Payroll Payable
95
Payroll Distribution
Work in process
20
FOH
30
Administrative expense
40
Selling expenses
10
Payroll expenses
100
Payment
Accrued payroll
95
Bank
95
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PRACTICE QUESTION
Direct Labor
15,000
Indirect Labor
10,000
Sales Salaries
7,000
Administrative Salaries
8,000
Total
40,000
Deductions
Income tax
4,000
Group insurance
1,000
Required:
Pass journal entries to record Payroll expense and its payment
Solution
1-
Payroll expense
40,000
Income tax (Payable)
4,000
Group insurance (Payable)
1,000
Payroll Payable
35,000
2-
Payroll payable
35,000
Voucher payable
35,000
3-
Voucher payable
35,000
Bank
35,000
4-
Work in process
15,000
FOH
10,000
Selling expense
7,000
Administrative
8,000
Payroll expenses
40,000
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Table of Contents:
  1. COST CLASSIFICATION AND COST BEHAVIOR INTRODUCTION:COST CLASSIFICATION,
  2. IMPORTANT TERMINOLOGIES:Cost Center, Profit Centre, Differential Cost or Incremental cost
  3. FINANCIAL STATEMENTS:Inventory, Direct Material Consumed, Total Factory Cost
  4. FINANCIAL STATEMENTS:Adjustment in the Entire Production, Adjustment in the Income Statement
  5. PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS:Gross Profit Margin Rate, Net Profit Ratio
  6. MORE ABOUT PREPARATION OF FINANCIAL STATEMENTS:Conversion Cost
  7. MATERIAL:Inventory, Perpetual Inventory System, Weighted Average Method (W.Avg)
  8. CONTROL OVER MATERIAL:Order Level, Maximum Stock Level, Danger Level
  9. ECONOMIC ORDERING QUANTITY:EOQ Graph, PROBLEMS
  10. ACCOUNTING FOR LOSSES:Spoiled output, Accounting treatment, Inventory Turnover Ratio
  11. LABOR:Direct Labor Cost, Mechanical Methods, MAKING PAYMENTS TO EMPLOYEES
  12. PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans
  13. PIECE RATE BASE PREMIUM PLANS:Suitability of Piece Rate System, GROUP BONUS SYSTEMS
  14. LABOR TURNOVER AND LABOR EFFICIENCY RATIOS & FACTORY OVERHEAD COST
  15. ALLOCATION AND APPORTIONMENT OF FOH COST
  16. FACTORY OVERHEAD COST:Marketing, Research and development
  17. FACTORY OVERHEAD COST:Spending Variance, Capacity/Volume Variance
  18. JOB ORDER COSTING SYSTEM:Direct Materials, Direct Labor, Factory Overhead
  19. PROCESS COSTING SYSTEM:Data Collection, Cost of Completed Output
  20. PROCESS COSTING SYSTEM:Cost of Production Report, Quantity Schedule
  21. PROCESS COSTING SYSTEM:Normal Loss at the End of Process
  22. PROCESS COSTING SYSTEM:PRACTICE QUESTION
  23. PROCESS COSTING SYSTEM:Partially-processed units, Equivalent units
  24. PROCESS COSTING SYSTEM:Weighted average method, Cost of Production Report
  25. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Accounting for joint products
  26. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Problems of common costs
  27. MARGINAL AND ABSORPTION COSTING:Contribution Margin, Marginal cost per unit
  28. MARGINAL AND ABSORPTION COSTING:Contribution and profit
  29. COST VOLUME PROFIT ANALYSIS:Contribution Margin Approach & CVP Analysis
  30. COST VOLUME PROFIT ANALYSIS:Target Contribution Margin
  31. BREAK EVEN ANALYSIS MARGIN OF SAFETY:Margin of Safety (MOS), Using Budget profit
  32. BREAKEVEN ANALYSIS CHARTS AND GRAPHS:Usefulness of charts
  33. WHAT IS A BUDGET?:Budgetary control, Making a Forecast, Preparing budgets
  34. Production & Sales Budget:Rolling budget, Sales budget
  35. Production & Sales Budget:Illustration 1, Production budget
  36. FLEXIBLE BUDGET:Capacity and volume, Theoretical Capacity
  37. FLEXIBLE BUDGET:ANALYSIS OF COST BEHAVIOR, Fixed Expenses
  38. TYPES OF BUDGET:Format of Cash Budget,
  39. Complex Cash Budget & Flexible Budget:Comparing actual with original budget
  40. FLEXIBLE & ZERO BASE BUDGETING:Efficiency Ratio, Performance budgeting
  41. DECISION MAKING IN MANAGEMENT ACCOUNTING:Spare capacity costs, Sunk cost
  42. DECISION MAKING:Size of fund, Income statement
  43. DECISION MAKING:Avoidable Costs, Non-Relevant Variable Costs, Absorbed Overhead
  44. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS
  45. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS:MAKE OR BUY DECISIONS