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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
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LESSON # 12
PAYROLL AND INCENTIVES
Wages are paid to the workers as the reward of their labor and service. Different systems of
remuneration have been devised for meeting the requirements of both employees and employers.
Usually the employer makes a specified monetary payment to workers for a specified work or job
done. The specified monetary payment or minimum wages could either be related to a particular
hours of attendance or to the quantum of work.
Thus the wages are paid to the workers either for the time spent by them in an organisation or the
goods or services produced for it. So there are two basic systems of remunerating labor. One is
related to the time and the other relates to the quantum of work.
In between these two basic or extreme systems of labor remuneration there are a number of vari-
ants in vogue in many industries. Organized trade unions and state regulatory measures have
significantly contributed to the introduction of various bonus and incentive schemes for the labor.
Demand for increased wages is a natural consequence on the part of labor while the employer
tends to resist this demand. However, it must be borne in mind that high wages do not necessarily
results in higher cost of production.
If labor is satisfied with high wages it may ultimately lead to increased production and productivity.
The increased production and productivity will in return results in reduced labor and overhead cost
per unit. It is also essential requirement of a good wage system.
The aims of a wage system should be the introduction of a fair wage. A good wage system should
have, among others, the following features:
1. The system of wage payment should be fair to all workers
2. A guaranteed minimum wage should be assured to all workers.
3. The system should be acceptable to workers so as to avoid the work to rule, stoppage of
work and slow-downs.
4. It should have the elements of simplicity, certainty and flexibility.
5. It should provide adequate incentives to workers.
6. It should be in conformity of various labor laws and regulations both local and national.
7. It should invariably contain an increment clause providing for an automatic rise in wages
and attendances as cost of living index number increases.
8. The wage system should be simple and practicable so as to keep its operational and
administrative cost at a minimum.
Systems of Wages
Basically there are two principal systems of wages. They are:
(i) Time wage
(ii)Piece rate or Piece work
1. Time base wage
Under this system, wages to a worker are paid on time basis irrespective of the quantum of
production. The wage is measured on the basis of unit of time i.e. hourly, daily, weekly or monthly.
The formula is:
Hours worked x Rate per hour.
Assuming a worker is paid Rs. 110 per hour and he has spent 200 hours during a particular month
in a factory, his wages will be:
Rs. 22,000 i.e. (Time x Rate i.e. 200 x Rs.110).
2. Piece Rate wage
Under this method of remuneration a worker is paid on the basis of production and not time taken
by him to perform the work. This is one of the simplest and most commonly used of all incentive
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schemes. The rate is expressed in terms of certain sum of money for every unit produced, e.g. Rs 2
per unit. The formula is:
Units produced x Rate per unit.
Suppose a worker is paid Re. 50 per unit and he has produced 20 units in 7 hours. His total wages
will be:
Rs. 1,000 i.e. (Units x Rate i.e. 20 x Rs.50)
However, a well regulated piece rate system has a guaranteed minimum wage. A well regulated
piece rate system, with a guaranteed minimum wage rate of compensation is much superior over
the time rate system.
Piece rate with guaranteed wage rate
Under this system a worker receives the straight piece rate for the number of pieces he produces,
provided that his total remuneration is more than his earnings on a time rate basis. If the piece rate
earnings fall below the minimum level of his earnings then he is paid on the time rate basis per
hour/per day).
Premium Plans
In between the two principal systems of remuneration described above, there are a variety of
bonus and premium plans of compensating workers for their extra efforts and skills. The basic
objectives of various bonus and premium plans are:
a. to induce the workers to increase the production and productivity,
b. to provide them additional wages for their skill and efforts,
c. to raise the morale of the labor high,
d. to reduce the cost of production,
e. to retain the services of good workers,
f. to induce the workers to serve the organisation with loyalty and sincerity, and
g. to establish better labor-management relations.
Essential futures of sound wage incentive plan:
Various incentive wage schemes have been designed to overcome the drawbacks of two principal
systems of labor compensation. A system of wage payment that would ensure both quality and
quantity of product is known as Incentive or Bonus or Premium plan. Essentially, all incentive
plans are a combination of the two basic wage plans, i.e., time rate and piece rate.
The following are some essential features of an incentive plan:
1. The plan should be acceptable to the workers, trade unions and management.
2. The incentive should be related to the efforts involved and should be sufficiently high
so as to provide inducement to greater effort.
3. It should be simple and should be understood by all workers easily.
4. The standard time or norms upon which wage incentive is based should be determined
on the basis of lime and motion studies.
5. Standards once fixed should not be changed unless it is necessitated by the change in
the method of work. Likewise unilateral and unwarranted rate cuttings should be
avoided.
6. No upper limit should be placed upon the amount of individual earnings.
7. The incentive plan should be aim at increasing production, reducing cost, and should
influence the workers morale.
8. The scheme should be operated without excessive and operative cost.
9. It should be consistent and incentive should be based on properly assessed lime values
of respective jobs.
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10. The scheme should motivate the employees towards attainment of management
objectives by means of coordinated efforts of all concerned.
11. The grievances of the workers especially in respect of work standard and incentive
rates should be removed at once.
The success of an incentive plan largely depends on the mutual co-operation and understanding
between employer and employees and immediate removal of workers' grievances. And above all,
the payments of incentive or bonus should be made as soon as possible after the work is
completed.
Some Important Incentive Wage Plans:
Some of the important incentive wage plans are briefly discussed here with practical examples.
These are:
Time Rate Based Premium Plan
(1) Halsey Premium Plan.
(2) Halsey-Weir Premium System.
(3) Rowan Plan.
Piece Rate Based Premium Plan
(4) Taylor's Differential Piece Rate System.
(5) Merrick Differential Piece Rate Plan-
While calculating total earnings of a worker under different incentive wage schemes, the following
four elements must be taken into account: (i) Unit of output, (ii) Standard time, (iii) Time
worked, and (iv) Time saved.
Time Rate Based Premium Plans
Halsey Premium Plan
Under this system, a standard time is fixed for each job or operation. Time rate is guaranteed to a
worker and if he completes the job within standard time or more than the standard time, he is paid
standard rate.
But if the Job is completed in less than the standard time fixed for the job, he is given wages for
the actual hours taken plus bonus equal to one half of the wage of the time saved.
Gross Wages = (Time worked x wage rate) + (½ Time saved x wage rate)
PRACTICE QUESTION
Q. 1
Wage rate per hour
Rs. 1.50
Time allowed for the job
16 hours
Time taken
12 hours.
Required:
1. Calculate the Gross earnings of the worker.
2. Find out effective "rate of earnings"
Solution: (Halsey premium plan)
Gross Earnings
Basic Pay
12 x 1.5
=
18
Bonus Pay
½ (4)x 1.5
=
3
21
Effective rate of earning
Rs21/12 hours = Rs. 1.75
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Halsey-Weir Premium Plan
Under this method, other things being the same as Halsey Plan, the rate of premium usually
applied is 33.33: 66.67 sharing plan basis. In practice the bonus is on a 50: 50 sharing scheme.
Q. 2
Calculate the total earnings and effective rate of earning per hour from the practice question given
above, if the worker is paid according to Halsey-Weir premium plan.
Solution: (Halsey-Weir premium plan)
Gross Earnings
Basic Pay
12 x 1.5
=
18
Bonus Pay
33.33% of (4) x 1.5
=
2
20
Effective rate of earning
Rs20/12 hours = Rs. 1.67
Rowan Premium Plan
This system is similar to the above two plans. The worker is guaranteed at ordinary rate of wages
and bonus is paid in respect of time saved.
Under the Rowan system the bonus hours are calculated as the proportion of the time taken which
the time saved bears to the standard time allowed.
Thus under this system a different method of calculating bonus is applied.
Step I
The bonus rate is calculated as:
Time allowed ­ Actual time taken x 100 = %
Time allowed
Step II
This bonus rate is then applied on the basic pay to calculate the bonus pay.
Basic Pay x bonus rate = bonus pay
Q. 3
Calculate the total earnings and effective rate of earning per hour from the practice question given
above, if the worker is paid under Rowan bonus plan.
Solution: (Rowan premium plan)
Bonus rate = 16 ­ 12 x 100 = 25%
16
Gross Earnings
Basic Pay
12 x 1.5
=
18.00
Bonus Pay
18 x 25%
=
4.50
22.50
Effective rate of earning
Rs 22.5/12 hours
= Rs. 1.875
OVERTIME
Normally an employee is required to work for a set number of hours every week. There may
however be occasions where the employer will ask the employee to work for longer hours.
Overtime is the time worked over and above the employee's basic working week.
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Overtime must not be confused with flex-time. In a flex-time system an employee is allowed to
work extra hours earlier in the week or month, in return for which he will work fewer hours later
on. His overall number of hours worked remains constant.
Overtime is time that is paid for, usually at a premium, over and above the basic hours for the
period.
Overtime by direct workers might be incurred for two reasons:
-  Either to make up for lost time earlier in the production process or
-  In order to produce more of the product than was originally anticipated.
Overtime being worked means that more units of a product are produced. However, if the
overtime is being worked to make up for lost production earlier in the process then the units
produced in the overtime may simply be enough to bring production back up to its anticipated
level.
Overtime that is being worked in order to make up for unnecessarily lost production time is
avoidable and should not have occurred.
Overtime that is necessary in order to fulfill customer orders is unavoidable overtime.
Calculating Overtime Pay
Hourly Paid Workers
Hourly paid workers may be paid overtime at various different rates. For example, the hourly rate
of overtime may be the same as the basic rate of pay or higher than the basic rate of pay.
It may either be expressed as a higher monetary amount, or as a proportion of basic pay, such as
'time and a half.
The hourly rate of overtime may vary according to when the overtime is worked. For example the
evening rate may be 'time and a half, whereas the weekend rate may be 'double time'.
The hourly rate may vary with the number of overtime hours worked. For example the first 5
hours may be at 'time and a half, and additional hours at 'double time'.
Weekly Paid Workers
The overtime pay is the number of hours of overtime worked, multiplied by the rate at which
overtime is paid.
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PRACTICE QUESTION
S normally works a 35 hour week, and is paid Rs.5 per hour. In one week she works 12 hours of
overtime, one hour each week day, and 7 hours on Saturday.
How much is her overtime-pay if:
(a) She is paid time and a half for all overtime hours?
(b) She is paid time and a half for evening overtime and double time for weekend overtime?
(c) She is paid time and a half for the first 8 hours overtime and double time thereafter?
Solution
S's overtime pay is:
(a)
Basic rate of pay
Rs. 5 per hour
Overtime rate of pay
Rs. 5 x 1 ½ times = Rs. 7.50 per hour
Overtime pay
12 hours @ Rs.7.50 per hour = Rs. 90.00
(b)
Basic rate of pay
Rs. 5 per hour
Overtime rate of pay evenings Rs. 5 x 1 ½= Rs. 7.50 per hour Overtime rate of
pay
weekends Rs. 5 x 2
= Rs. 10.00 per hour
Overtime pay 5 hours @ Rs. 7.50 per hour
37.50
7 hours @ Rs. 10.00 per hour
70.00
107.50
(c)
Basic rate of pay
Rs. 5 per hour
Overtime rate of pay -first 8 hours Rs. 5 x 1 ½
= Rs. 7.50 per hour
Overtime rate of pay-excess hours Rs. 5x2
= Rs. 10.00 per hour
Overtime pay 8 hours® Rs. 7.50 per hour
60.00
4 hours® Rs. 10.00 per hour
40.00
100.00
Salaried Staff
Not all salaried staff will be paid overtime. If they are, the rate at which overtime is paid may vary
according to when the overtime is worked, in precisely the same way as for weekly paid employees.
The difference is that the pay of salaried staff is usually expressed as an annual rate, and this must
be converted to an hourly rate before the overtime can be calculated.
This is done by dividing the annual salary by 52 to give the weekly salary, and further dividing this
by the number of hours an employee is contracted to work for.
It should be noted that the contract of employment may override this calculation, setting a rate of
overtime pay.
PRACTICE QUESTION
Alee works a 35 hour week for an annual salary of Rs.18,200. He is expected to work up to 5 hours
of overtime for no extra pay, but thereafter will be paid overtime pay at the rate of time and a half.
One week he works 8 hours of overtime. What is his overtime pay?
Solution
Hint: There are 52 weeks in a year and there are 35 working hours in a week
Alee's basic hourly rate of pay is:
Rs.18,200 x 1/52 x 1/35 =Rs.10
The hourly rate of overtime pay, at time and a half is:
Rs.10 x 1 ½ =Rs.15.00
Alee will not be paid for the first 5 hours of overtime so his overtime pay is:
(8 - 5) hours = 3 hours @ Rs.15 = Rs.45.00
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COMMISSION
In some jobs, employees may be remunerated by a basic salary, plus an additional amount
specifically related to that employee's performance.
Commission is an amount paid to an employee based on that employee's performance.
Commission is most commonly paid to salesmen, based on the volume of sales that they have
achieved in a given period. In some cases they may have a very low basic salary, so that
commission forms the largest part of their pay.
In its simplest form, commission will usually be expressed as a percentage of sales achieved in the
previous period e.g. 1% of sales.
Commission may also be paid at different scales, so that the higher the sales, the higher the
commission. For example, a salesman may be paid 2% commission on the first Rs.10,000 of sales,
2.5% on the next Rs.10,000, and 3% on any additional sales.
This basis may be appropriate where an employee sells a large number of small value items. If he
sells instead higher value contracts, the level of commission may vary with the value of the
contract. For example the rate of commission may be 2% for contracts worth up to Rs.10,000,
2.5% for contracts worth up to Rs.20,000, and 3% for larger contracts.
Since the incentive is for the employee to make a large volume of sales, it is important for the
employer to ensure that the salesman is only rewarded for good sales. The commission scheme
may contain a proviso that the commission will only be paid once the customer has paid up, or
once the customer's creditworthiness has been checked.
PRACTICE QUESTION
Haroon is a salesman, selling machinery. He receives a commission of 2% on all sales, with an
additional 0.5% for any item of machinery selling for more than Rs.10,000. In addition he receives
a further 0.5% on sales in excess of Rs.100,000 per month.
During July his total sales amounted to Rs.110,000. Included in this were two expensive machines,
one selling for Rs.12,000, and the other for Rs.17,000.
How much commission does Haroon earn?
Solution
Haroon earns commission of:
Rs.
Basic commission Rs.110,000 x 2%
2,200
Expensive machines Rs. (12,000 + 17,000) x 0.5%
145
Sales over Rs.100,000 Rs.(110,000-100,000) x 0.5%
50
Total commission
2,395
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PROBLEM QUESTIONS
Q. 1
From the information given below calculate the earnings of each employee, under the following
methods of wage payment.
(i)
Halsey Premium Bonus Scheme.
(ii)
Halsey-Weir Premium Bonus Scheme.
(iii)
Rowan Premium Bonus Scheme.
Employee
A
B
C
Time allowed hours per 100 units
35
40
42
Wages per unit Rs.
2
3
4
Hourly rate Rs.
7
8
10
Actual time taken in hours
50
48
46
Actual units produced
200
150
125
Q. 2
Ten men work as a group. When the weekly production of the group exceeds standard (200 pieces
per hour) each man in the group is paid a bonus for the excess production in addition to his wages
at hourly rates. The bonus is computed thus:
The percentage of production in excess of the standard amount is found and one half of this
percentage is considered as the men's share. Each man in the group is paid as a bonus this
percentage of a wage rate of 50 paisa per hour. There is no relationship between the individual
work man's hourly rate and the bonus rate. The following is one week's record:
Days
Hours worked
Production
Monday
90
22,100
Tuesday
88
20,600
Wednesday
90
24,200
Thursday
84
20,100
Friday
88
20,400
Saturday
40
10,200
Total
480
117,600
(i)
Compute the rate and amount of bonus for the week.
(ii)
Compute the total pay of "A" who worked 41 hours and was paid 35 paisa per hour
basic and of "B" who worked 44 hours and was paid 30 paisa per hour basic.
Q. 3 Using the information given below you are required to calculate the amounts earned by each
employee under each of the following remuneration methods:
(i)
Piece work (with guaranteed hourly rates)
(ii)
Hourly rate;
(iii)
Bonus system (under which the employee receives 50% of time savings).
Also calculate the gross wages paid to each employee under each of the above method.
Employee
Employee
Employee
A
B
C
Time allowed:
Hours per 100 units
23
32
38
Price per unit in Paisa
12
20
15
Guaranteed hourly rate
Re. 0.60
Re. 0.75
Re. 0.50
Actual time taken in hours
40
42
39
Actual units produced
200
125
150
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Q. 4
(a) How is incentive wages calculated under (i) Halsey and (ii) Rowan incentive schemes of wages
payment? Explain the difference between them and the advantage to the worker under these two
methods of incentive payment.
(b) From the following data tabulate the total earnings per hour of each worker separately under (i)
Halsey and (ii) Rowan schemes of incentive payment.
(a) Worker
A
B
C
D
E
F
(b) Time allowed hrs.
3
4
5
6
7
8
(c) Actual time hrs.
5
3
4
5
3
3
(d) Basic wages per hrs. in Rs. 2
2
2
2
2
2
Q. 5
Kirn is paid commission of 5% on the first Rs.20,000 of sales, and 7,5% on any sales in excess of
this amount. However she is only paid the commission when either the customer has paid for the
order, or has taken out a financing agreement.
In October she made sales of Rs.35,000, However two customers refused to pay or take out a
financing agreement. One had ordered goods costing Rs.1,500, and the other goods costing
Rs.2,500.
How much commission will Kirn receive?
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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