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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
VU
LESSON # 13
PIECE RATE BASE PREMIUM PLANS
Piece Rate Wages
Under this method of remuneration a worker is paid on the basis of production and not lime taken
by him to perform the work. This is one of the simplest and most commonly used of all incentive
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 Rs. 0.50 per unit and he produces 18 units in 7 hours. His total wages
would be: 18 x Rs. 0.50 = Rs. 9.
However, a well regulated piece rate system has a guaranteed minimum wage.
Advantages of piece rate or piece work system:
1. There is a direct connection between effort and reward. Efficient workers are paid
according to their performance and hence a sense of competition is created among
workers.
2. Since there is a direct incentive to work there is always a tendency on the part of worker to
produce more by adopting correct procedure and techniques of production.
3. The increased volume of production results in decreased cost of production specially
overhead cost per unit.
4. Since the cost per unit is fixed computation of labor costs of production in advance is
possible.
5. Under this system every worker assumes the responsibility of his time and output so there
is considerable scope of reduction in managerial cost.
6. Since the payment is linked with results the idle time costs are reduced to minimum.
There are certain disadvantages of piece rate system:
1. At the initial stage, setting of piece rates or standard hours involves lot of difficulties and a
considerable amount of expenditure has to be incurred- It is difficult to establish fair
standard- If high standard or rates arc established, it is very difficult to reduce them
subsequently.
2. Quality of work is another casualty of this system. Since the payment is made on the basis
of output, every worker tempts to produce more and more irrespective of quality of
product. This results in production of substandard items, high rate of rejection and
ultimately increased cost of production per unit.
3. For the maintenance of quality of standards a rigid system of supervision and inspection is
necessary.
4. The workers tend to work for longer hours in temptation to earn more- This leads to
excessive fatigue, ill-health and risk of accident.
5. There is always danger to the flow of production and regularity of minimum wage to the
workers. For some time a worker works with great zeal and enthusiasm to earn more and
then absents himself from work or comes late. In all these cases not only the flow of
production is adversely affected but also there is no certainly of regular payment of wages
to the worker.
6. This system is unsuitable where the quality of work is given the lop preference.
7. Under this system a uniform rate is paid regardless of quality and quantity of work. There is
no special incentive for exceptionally good workmanship and expertise, likewise, no
particular penalty is imposed for producing less or substandard goods.
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Cost & Management Accounting (MGT-402)
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8. The system does not provide security of minimum payment of wages to the worker. Hence
it is opposed by the trade unions on the ground that frequently workers are laid off or
their remuneration is reduced due to lack of work or inefficiency of management.
These drawbacks are associated with the straight piece rate method, A well regulated piece rate
system, with a guaranteed minimum wage rate of compensation is much superior over the time
rate system. An improved version of straight piece rate is piece rate with guaranteed day 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).
Suitability of Piece Rate System
Piece rate system also known as 'payment by results' can be suitably applied under the following
conditions:
(i) The amount of work can be precisely measured and standardised.
{ii) The work is of repetitive nature.
(iii) If the productivity is closely related to skill and efforts.
(iv) The unit cost can be easily determined and controlled.
(v) If it is possible to fix a fair and acceptable piece rate.
(vi) Where lime cards are maintained for ensuring, regularity and punctuality of workers and
uninterrupted flow of production.
(vii) If there is no fear of unwarranted rate cutting by the management and the management
realizes the significance of the system.
Differential Piece Rates:
There are various differential piece rate plans. The differential piece rate plans aim at maximum
production by giving an additional incentive to increase output just at the stage at which the
worker would otherwise begin to feel that further efforts was not worthwhile. These schemes are
devised in such a manner that with the increase in efficiency of a worker his wages are
automatically increased. Some of the differential schemes are:
(1) Taylor Differential Piece Rate Plan
(2) Merrick Differential Piece Rate Plan
Taylor's Differential Piece Rate Plan:
This system was originated by W.F. Taylor, the father of scientific management. It is based on the
assumption that the degree of efficiency varies from worker to worker and hence the worker must
be paid according to their degree of efficiency.
Under this system two piece rates are fixed; one lower rate applicable to worker whose
production is below standard and another higher rate and is applicable to a worker whose
production is above the standard.
The efficiency of a worker may be determined as a percentage, either:
(i) of the time allowed for a job to the actual time taken, or
(ii) of actual output to the standard output, within a specified time.
For Example;
1.
Standard time allowed for a job
15 hours
Actual time taken for the job
20 hours.
2.
Standard output
5 units per hr
Actual output
6 units per hr
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Cost & Management Accounting (MGT-402)
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Efficiency under:
(1)
15/20 x 100
= 75%
(2)
6/5 x 100
= 120%
Under this system no guaranteed time rate is given. Moreover, the difference between the two rates
is very wide. The slow worker is penalized while the efficient worker is duly rewarded.
PRACTICE QUESTION
From the following particulars, calculate the earnings of workers under straight piece basis and
Taylor's Differential Piece Rate Plan.
Standard Time per piece
20 minutes
Normal rate per hour
Rs. 0.90
In a 9 hour day;
A produces
25 units
B produces
35 units
Differential to be applied 80% of piece rate below standard. 120% of piece rate at or above
standard.
Solution:
Standard production per hour  60 min/20 min
= 3 units
Standard production per day
3units x 9 hours
= 27 units
Per Piece rate
Rs. 0.90/3 units
= Rs. 0.30
Efficiency of:
Worker "A" is less than 100%
Worker "B" is more than 100%
Wages under Straight Piece Rate Basic:
Earnings of A
No. of units X Rate per unit
25 x 0.30 = Rs. 7.50
Earnings of B
30 x 0.30 = Rs. 9.00
Wages Taylor's differential piece rate basis:
Efficiency of A
92.25%
Efficiency of B
111%
Low piece rate in case of A
=80% of Rs. 0.30
=Rs. 0.24
High piece rate in case of B
= 120% of Rs. 0.30
=Rs. 0.36
Earning of A
25 x 0.24
=Rs. 6-00
Earning of B
30 x 0.36
=Rs-10.80.
It is clear from the above results that worker with low efficiency gets less wages under Taylor's
Differential Piece Rate System as compared to straight piece rate method.
The Taylor's Differential system is very beneficial to the efficient worker and is simple to
understand and operate. However, it penalizes the inefficient workers.
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Cost & Management Accounting (MGT-402)
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Merrick Differential Piece Rate System:
Merrick Differential system is a slight modification of the Taylor's system and uses three rates
instead of two. Under this system the worker is not penalized even if his performance does not
exceed 80 per cent of the High Task. The three rates are as under:
Efficiency
upto 80%
Normal Piece rate applicable
upto 100%
10% above normal rate above 100%
20% above normal rate.
Under this system also day wages are not guaranteed. The following illustration makes the working
of this system clear.
PRACTICE QUESTION
From the following particulars calculate the total earnings of the three workers who are paid wages
under the Merrick Differential System.
Normal piece rate (upto 80% of High Task Output)
Rs. 5 per unit
High Task
40 units per week
Output of the workers for the week.
A
32 units
B
37 units
C
42 units
Also find out their wages if they are paid on the straight piece rate basis.
Solution
Efficiency level:
A. 32/40 x 100 = 80%
B. 37/40 x 100 = 92.5%
C. 42/40 x 100 = 105%
Wages of A at normal rate (since his efficiency is below standard)
=32 x Rs.5=Rs 160.
Wages of B at normal rate plus 10% above normal rate (since his efficiency is above 80% of High
Task but below 100 %.)
= 37x Rs. 5.50 = Rs. 193.50
Wages of C at normal rate plus 20% of normal rate (since his efficiency is above 100%)
= 42 x Rs.6 = Rs.252.
If Straight piece rates are paid:
Wages of A=32 x Rs.5 = Rs. 160
Wages of B=37 x Rs.5 = Rs. 185
Wages of C=42 x Rs.5 = Rs. 210
Thus it is very clear that even if the output of a worker is below standard, he is paid at normal rate
of wages. Under this scheme bonus is within the reach of every worker since it is paid just at 80
per cent of the efficiency and is step-up after 10 per cent increase in output.
GROUP BONUS SYSTEMS
It is impossible for a worker of assembly line or manufacturing concern to increase his output
without the assistance and co-operation of the entire group of workers. In such situations
companies have successfully introduced group incentive schemes.
Common characteristics of group bonus schemes
(a) A standard time is set for the completion of a job.
(b) If the time taken is greater than the time allowed, the workers in the group receive time
wages.
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(c) If the time taken is less than the time allowed, the group receives a bonus on time saved.
Advantages of group bonus systems
(a) Encouraging team spirit. Mutual dependence engenders mutual trust.
(b) Good group incentive plans assist in the reduction of labor turnover, accidents,
spoilage, waste and absenteeism.
(c) Good output will qualify for bonus and this can be earned only if each member has
performed his/her task satisfactorily. There is therefore a built-in system of inspection
and such a scheme reduces the amount of supervision necessary.
(d) High output should result as the slower workers in the group follow the example of faster
workers. The cost per unit should decrease as the fixed overhead will be spread over a
greater number of units.
Disadvantages of group bonus schemes
(a) A faster worker in the group may real dissatisfy with his earnings; this may cause dissension
within the group. In such cases he may be paid a higher rate;
Alternatively, he may be transferred.
(b) Sickness of members may cause the output of the group to suffer. For the incentive scheme to
be successful, it is necessary lo have able substitutes to cover sickness, holidays and other absences.
(c) Additional administrative costs may result.
(d) In attempting to produce greater output, quality of the work may deteriorate and there could be
excessive material wastage.
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Cost & Management Accounting (MGT-402)
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Total Wages
The total wages of a worker includes among others basic pay, dearness allowance, employer's
contribution to provident fund and state insurance, and other benefits.
Some of these benefits are treated as part of direct labor costs while others are treated as indirect
labor costs.
For the purposes of charging a particular job or jobs, the wage rate is to be ascertained. For this
the total of all wages and benefits is found out and then divided by the effective hours worked.
The wages rate thus derived would be labor cost per hour and the job should be charged
accordingly. The operative part is explained with the help of the following practice question.
PRACTICE QUESTION
Q. 1
Calculate labor cost per man-day of 8 hours from the following particulars.
1. Basic Salary
Rs. 4 per day
2. Dearness Allowance
25 paisa, per every point over 100 cost of living
index for working class. Current cost of living index
is 500 points
3. Leave Salary
10% of (1) and (2)
4. Employer's contribution to
provident fund
8% of (1) (2) and (3)
5. Employer's contribution to
Pension fund
2.5% of (1) (2) and (3)
6. Labor amenities
Rs. 20 per head per month
7. Number of working
days in a month
25 days of 8 hours each.
Solution
Statement of Labor Cost (per man-day of 8 boors)
Basic Salary
4.00
Dearness Allowance
4.00
Leave Salary-10%
0.80
Employer's contribution to Provident Fund
0.70
Employer's contribution to Pension Fund
0.22
Labor amenities
0.80
Total
10.52
Q. 2
The Lemon Car Company operates two shifts. The company's day shift pay rate is Rs. 15.00 per
hour and the night shift pay rate is Rs. 15.50 for the same work (Rs.0.50 more per hour).
Pass appropriate accounting entry to record payroll of a night shift worker who works in 35 hours
in the week.
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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