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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
VU
LESSON # 14
LABOR TURNOVER AND LABOR EFFICIENCY RATIOS
& FACTORY OVERHEAD COST
Labor Turnover:
Labor turnover may be defined as the rate of change in the composition of the labor force of an
organisation high rate of labor turnover denotes that labor is not stable and there is frequent
change in the labor force in the organisation. The high labor turnover rate is an important
indication of high labor cost. It is therefore not desirable.
Measurement of Labor Turnover:
There are various methods for the measurement of labor turnover. The choice of method of
measurement would depend on the organisation. But, however, once a particular method is adop-
ted for it, it should be followed for quite some times, so that a clear and comparative picture is
obtained. The methods of measurement are:
(1) Separation method;
Labor turnover is measured by dividing the total number of separations (workers left
the organisation) during a period by the average number of workers on the pay roll.
Labor turnover
Number of separations in a period x 100 Average number of
workers in a period
(2) Flux method:
Labor turnover is measured by dividing the total number of separations and
replacements by the average number of workers.
Labor turnover
Number of separations + number of replacement x 100 Average number
of workers during the period.
(3) Replacement method:
Labor turnover is measured by dividing the number of replacements during a
period by the average number of workers employed in that period.
Labor turnover
Number of workers replaced during the period
Average number of workers during the period.
Average workers employed = Number of workers at the beginning of the period + Number of
workers at the end of that period divided by 2.
PRACTICE QUESTION
The personnel department of a company has supplied the following information relating to its
work force during the month of June, 2006.
Number of workers:
1st. June
1900
th
30 . June
2100
During the month 60 persons were discharged and 20 left the company. During the month 200
workers were engaged out of which only 40 workers were appointed against the vacancy caused by
the number of workers separated and the remaining on account of an expansion scheme of the
company.
Calculate labor turnover rate and equivalent rate under different methods.
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Cost & Management Accounting (MGT-402)
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Solution:
Average number of workers
1900 + 2100 = 2,000
2
1. Separation Method:
Labor turnover ratio
80 x 100
=
4%
2,000
Equivalent annual turnover
4 x 365
=
48.67%
30
2. Flux Method:
Labor turnover
80 + 40 x 100 =
6%
2,000
Equivalent annual turnover
6 x 365
=
73%
30
3. Replacement Method:
Labor turnover
40x 100
=
2%
2,000
Equivalent annual turnover
2 x 365
=
24.33%
30
The working results of the above practice question reveals wide fluctuations among the different
annual labor turnover rates obtained by different methods of measurement.
The flux method of labor turnover denotes the total change in the composition of labor force.
While replacement method takes into account only workers appointed against the vacancy caused
due to discharge or quitting of the organisation. This method does not take into account the
workers employed under the expansion schemes of the company.
However, it must be noted that if a department is closed and workers retrenched, it would not be a
case of labor turnover.
The higher percentage of labor turnover, the higher will be the cost of recruitment and training of
new workers. A higher rate of labor turnover also reduces the efficiency since good deal of work
would be done by new inexperienced workers. The objective of management therefore should be
to keep the percentage of labor turnover at minimal. However, in any organisation a minimum rate
of labor turnover will always occur particularly due to retirement, marriages, death and personal
betterment.
Causes of Labor Turnover
Labor turnover arises because of various factors including dissatisfaction with job, low rate of
wages, unsatisfactory working conditions and non-availability of adequate basic amenities.
The causes of labor turnover may be sub-divided as:
(1) Avoidable causes, and
(2) Unavoidable causes.
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(1) Avoidable Causes:
a) These include low wages rate in the present organisation and the worker may look
for higher wages elsewhere,
b) Dissatisfaction with job,
c) Bad working conditions,
d) Long and odd working hours,
e) Unsatisfactory relationship with the supervisors,
f) Bad relationship with the fellow workers,
g) Lack of adequate recreational facilities,
h) Inadequate housing, medical facilities,
i) Unfair methods of promotion and lack of promotions avenues,
j) Lack of planning and foresight on the part of management, seasonal nature of
industry, non-availability of raw materials, power, etc.
(2) Unavoidable Causes include:--
a) Personal betterment of worker,
b) Retirement and death leading to labor turnover,
c) Domestic responsibilities--to look after old parents,
d) Accident or illness rendering workers permanently incapable to work,
e) Dismissal or discharge due to insubordination, negligence, inefficiency, etc.,
f) Marriages, specially in case of women workers,
Effect of Labor Turnover
The higher rate of labor turnover results in increased cost of production. This is due to--
(i)
Increased cost of new recruitment, training,
(ii)
Interruption of production,
(iii)
Decrease in production due to inefficiency and inexperience of
newly recruited workers,
(iv)
The new workers are more accident prone and are liable to cause
more damage to machinery, tools than old employees,
(v)
Losses due to wastage, spoilage and defectives,
(vi)
Increased number of accidents causing loss of output and increase
in medical expenses and cost of repairs,
(vii)  Lack of cooperation and coordination between old and new
employees resulting fall in output and increased cost of production,
LABOR EFFICIENCY AND UTILISATION
Labor is a significant cost in many organisations and it is important to continually measure the
efficiency of labor against pre-set targets.
Measuring labor efficiency
To measure labor efficiency: Compare actual efficiency with predetermined targets (or budgets)
using `standard hours'.
A standard hour is the number of production units which should be achieved by an experienced
worker within a period of one hour.
We can assume that all organisations will benefit from efficient labor, thus it is important to
measure how efficient workers are and identify opportunities for improvement.
The following practice question shows the calculation of the efficiency ratio.
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PRACTICE QUESTION
Standard time allowed per unit
30 minutes
Actual output in period
840 units
Actual hours worked
410
Budget hours worked
400
The efficiency ratio is calculated by the following formula:
Actual output measured in standard hours Actual hours
Actual hours
840 x hours (30 minutes) = 420 hours
420 x 100 = 102.44%
210
Problem Question
Calculate the efficiency ratio from the following data.
Standard time allowed per unit
15 minutes
Actual production
900 units
Actual hours
250
Budget hours
200
FACTORY OVERHEAD COST (FOH)
Factory overhead costs are those costs incurred which cannot be identified directly to cost unit.
These are incurred in many different parts of organisation.
These include:
1. Indirect materials
2. Indirect labor and
3. Indirect costs attributable to production and the service activities associated with
manufacturing.
Marketing, general administration, research and development costs that are not associated with
manufacturing are not usually treated as overheads for this purpose.
Factory overhead costs are incurred in three main centers:
 Production centers
costs arising in production departments such as the costs of
fuel, protective clothing, depreciation and supervision.
 Service centers
the cost of operating support departments or sections
within the factory, for example, the costs of materials handling, production control, and
canteen.
 General costs centersgeneral production overhead such as factory rent/taxes, heating and
lighting and production management salaries.
The purpose of cost accounting is to provide information to the management. Management need
to know cost per unit as a basis for valuing inventory and for decision making.
FOH Cost Allocation & Apportionment
The total cost of factory overhead needs to be distributed among specific cost centers. Some items
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can be allocated immediately, e.g. the salary of a cost centre supervisor or indirect materials issued
to a cost centre. Other items need to be apportioned between a number of centers, e.g. factory rent
and taxes or the factory manager's salary.
Cost Allocation
It refers to the costs that can be identified with specific cost centers.
Apportionment
It refers to the costs that cannot be identified with specific cost centre but must be divided among
the concerned department/cost centers.
Steps of Allocation & Apportionment
1. Item wise collection of FOH cost.
2. Identifying cost centre (Production & Services).
3. Allocating and apportioning general F.O.H cost to the cost centers.
4. Apportioning FOH cost of service cost centers to the production cost centers.
5. Calculation of total FOH cost for each production cost centers.
6. Determining FOH rate for each production cost center.
FOH Absorption Rate
Finally FOH absorption rate is calculated at which the cost is absorbed in the cost unit. This is also
known as overhead absorption rate (OAR) this can be calculated as under:
OAR = Estimated F.O.H cost
Base
Bases for FOH Absorption Rate
Following can be used as base to calculate overhead absorption rate:
1. Direct Labor hours
2. Machine hours
3. No. of unit produced
4. Direct labor cost
5. Prime cost
Problem Question
Apportion each of the cost given in four cost centers A, B, C, and D
Supervision
Rs. 7,525
Indirect workers
6,000
Holiday pay & national Insurance
6,200
Tolling cost
9,400
Machine Maintenance labor cost
4,500
Powers
1,944
Small tools & Supplies
1,171
Insurance of machinery
185
Insurance of building
150
Rent & rates
2,500
Depreciation of machinery
9,250
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Basis of apportionment of different costs:
A
B
C
D
Total
1. Floor Space
1,800
1,500
800
900
5,000
2. Kilowatt hours
270,000
66,000
85,000
65,000
486,000
3. Cost of machine
30,000
20,000
8,000
16,000
74,000
4. Indirect workers
3
3
1
1
8
5. Total workers
19
24
12
7
62
6. Machine maintenance
3,000
2,000
3,000
1,000
9,000
hrs
7. Supervision cost
2,050
2,200
1,775
1,500
7,525
8. Tooling cost
3,500
4,300
1,000
600
9,400
9. Small tools & supplies
491
441
66
173
1,171
10. Machine running
30,000
36,000
19,000
8,000
93,000
hours
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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