Labour costs

Syllabus points

• Distinguish direct from indirect labour.
• Calculate wages under time rate, piece rate and premium bonus schemes.
• Account for overtime, idle time and labour-related overheads.
• Calculate and interpret labour turnover.

Direct and indirect labour

Direct labour is the wages of people who work on the product itself: the machinist, the assembler, the carpenter. It is part of prime cost.

Indirect labour is everyone else in the factory whose time cannot be traced to a unit: supervisors, maintenance staff, storekeepers, cleaners, quality inspectors. It is a production overhead.

Administration and selling staff are neither. Their wages are period costs charged to the relevant function, and they never enter the cost of a unit.

Time rate

Paid for hours worked, regardless of output.

wages = hours worked x rate per hour

It suits work where quality matters more than speed, or where output cannot be measured per person. It is simple to operate and gives the employee a predictable income, but it gives no incentive to produce more, so it needs supervision.

Piece rate

Paid per unit produced, regardless of time taken.

wages = units produced x rate per unit

It rewards output directly, and the labour cost per unit is constant, which makes costing easy. Against that, it can push quality down as workers rush, and income is uncertain if materials or machines fail.

Most schemes therefore include a guaranteed minimum wage, so the worker receives the higher of the piece-rate earnings and the minimum.

A worker producing 420 units at $0.60 a unit earns 420 times 0.60, which is $252. With a guaranteed weekly minimum of $280, the worker is paid $280, and the extra $28 is an indirect labour cost, because it bought no additional output.

A differential piece rate raises the rate once a target is passed, so all units may be paid at the higher rate once the target is met. Read carefully whether the higher rate applies to every unit or only to those above the target: the two give different answers and questions use both.

Premium bonus schemes

The worker is given a time allowed for a job and shares the value of any time saved.

The Halsey scheme pays half the time saved:

bonus = 50% x time saved x hourly rate

The Rowan scheme pays a proportion based on how much of the allowed time was used:

bonus = (time taken / time allowed) x time saved x hourly rate

A job is allowed 10 hours and completed in 7, at $12 an hour. The basic pay is 7 times 12, which is $84, and the time saved is 3 hours.

Under Halsey the bonus is half of 3 times 12, which is $18, giving total pay of $102.

Under Rowan the bonus is 7 over 10, times 3, times 12, which is $25.20, giving total pay of $109.20.

Rowan pays more here, and it protects the employer better when the time allowed was set too generously, because the bonus falls away as the time saved gets very large. Halsey is simpler to calculate and to explain to the workforce.

Overtime

Overtime pay splits in two.

• The basic rate hours are direct labour, exactly as normal hours are.
• The overtime premium, the extra above basic rate, is normally an indirect cost charged to overheads, because no single job should bear the accident of being made late in the week.

The exception is when overtime is worked at a specific customer's request to meet their deadline. Then the premium is direct and charged to that job.

Eight overtime hours at time and a half, on a basic rate of $10, gives $120 in total: $80 of direct labour and $40 of overtime premium going to overheads.

Idle time

Idle time is time paid for but not worked: machine breakdown, waiting for materials, a power cut.

Normal, unavoidable idle time is treated as an overhead, spread over production. Abnormal idle time, from an unusual event such as a strike or a flood, is written off to the income statement rather than absorbed into product cost, so that the cost per unit is not distorted by something that will not recur.

Labour turnover

labour turnover = employees leaving and replaced during the period / average number employed x 100

An average workforce of 250 with 30 replacements in the year gives 30 over 250, which is 12%.

High turnover costs money in ways that do not appear as one line in the accounts: recruitment and advertising, training, lower output while new staff learn, more waste and rework, more accidents, and lost knowledge.

Causes divide usefully into avoidable (poor pay, poor conditions, no promotion, bad supervision) and unavoidable (retirement, illness, relocation, family reasons). Only the first group can be acted on, and saying which group a cause belongs to is what a recommendation needs.

Common mistakes

• Treating the whole of overtime pay as indirect. Only the premium is.
• Treating supervisors' wages as direct labour.
• Forgetting the guaranteed minimum in a piece-rate calculation.
• Using time allowed instead of time taken to calculate basic pay in a bonus scheme.
• Mixing up the Halsey and Rowan formulas, or applying Rowan's fraction the wrong way up.
• Absorbing abnormal idle time into the cost per unit.
• Listing causes of labour turnover without separating avoidable from unavoidable.