Year: 2020

Direct labor cost is wages that are incurred in order to produce goods or provide services to customers. The total amount of direct labor cost is much more than wages paid. It also includes the payroll taxes associated with those wages, plus the cost of company-paid medical insurance, life insurance, workers’ compensation insurance, any company-matched pension contributions, and other company benefits.

Direct labor costs are most commonly associated with products in a job costing environment, where the production staff is expected to record the time they spend working on various jobs. This can be a substantial chore if employees work on a multitude of different products. In the services industries, such as auditing, tax preparation, and consulting, employees are expected to track their hours by job, so their employer can bill customers based on direct labor hours worked. These are also considered to be direct labor costs. In a process costing environment, where the same product is created in very large quantities, direct labor cost is included in a general pool of conversion costs, which are then allocated equally to all of the products manufactured.

A strong case can be made in some production environments that direct labor does not really exist, and should be categorized as indirect labor, because production employees will not be sent home (and therefore not be paid) if one less unit of product is manufactured – instead, direct labor hours tend to be incurred at the same steady rate, irrespective of production volume levels, and so should be considered part of the general overhead costs associated with running a production operation.

Calculate Direct Labor Cost per Unit

The amount incurred as direct labor cost depends on how efficiently the workers produced finished items. Usually, companies calculate a standard direct labor cost against which to compare their actual direct labor costs. Here is how to calculate direct labor cost per unit of production:

1. Calculate the direct labor hourly rate

First, calculate the direct labor hourly rate that factors in the fringe benefits, hourly pay rate, and employee payroll taxes. The hourly rate is obtained by dividing the value of fringe benefits and payroll taxes by the number of hours worked in the specific payroll period.

For example, assume that employees work 40 hours per week, earning $13 per hour. They also get $100 in fringe benefits and $50 in payroll taxes. Get the sum of the benefits and taxes (100+50) and divide the figure by 40 to get 3.75. The $3.75 is added to $13 to get an hourly rate of $16.75.

2. Calculate the direct labor hours

The direct labor hours are the number of direct labor hours needed to produce one unit of a product. The figure is obtained by dividing the total number of finished products by the total number of direct labor hours needed to produce them. For example, if it takes 100 hours to produce 1,000 items, it means that 1 hour is needed to produce 10 products, and 0.1 hours to produce 1 unit.

3. Calculate the labor cost per unitThe labor cost per unit is obtained by multiplying the direct labor hourly rate by the time required to complete one unit of a product. For example, if the hourly rate is $16.75, and it takes 0.1 hours to manufacture one unit of a product, the direct labor cost per unit equals $1.68 ($16.75 x 0.1).
4. Calculate the variance between the standard and actual labor cost

The variance is obtained by calculating the difference between the direct labor standard cost per unit and the actual direct labor cost per unit. If the actual direct labor cost per unit is higher than the standard direct labor cost per unit, it means that the company incurs more to produce one unit of a product than is expected, making the cost unfavorable to the business. If the actual direct labor cost is lower, it means that it costs lower to produce one unit of a product than the standard direct labor rate, and therefore, favorable.

There are so many expenditures which are incurred in respect of the employees of the business firm which are neither official nor personal; even then these are booked as business expenditure. For example:- Tea and refreshment expenses for the employees, medical expenses for the health of the employees or their family members, uniforms given to employees, concessional foods given to employees, personal accident insurance premium paid for employees etc. For control purpose, the sub heads may be created under staff welfare expense like tea & refreshment expenses, medical expenses, personal accident expenses, uniform expenses etc.

Employee welfare entails everything from services, facilities and benefits that are provided or done by an employer for the advantage or comfort of an employee. It is undertaken in order to motivate employees and raise the productivity levels.

In most cases, employee welfare comes in monetary form, but it doesn’t always bend that way. Other forms of employee welfare include housing, health insurance, stipends, transportation and provision of food. An employer may also cater for employees’ welfare by monitoring their working conditions.

Importance of employee welfare

Employee welfare raises the company’s expenses but if it is done correctly, it has huge benefits for both employer and employee. Under the principles of employee welfare, if an employee feels that the management is concerned and cares for him/her as a person and not just as another employee, he/she will be more committed to his/her work. Other forms of welfare will aid the employee of financial burdens while welfare activities break the monotony of work.

An employee who feels appreciated will be more fulfilled, satisfied and more productive. This will not only lead to higher productivity but also satisfied customers and hence profitability for the company. A satisfied employee will also not go looking for other job opportunities and hence an employer will get to keep the best talents and record lower employee turnover.

During employment, the offered benefits will determine whether an employee commits to an organization or not. As such, good employee welfare enables a company to compete favorably with other employers for the recruitment and retention of quality personnel.

Five Techniques of Inventory Control

1. Economic Order Quantity

A problem which always remains in that how much material may be ordered at a time. An industry making bolts will definitely would like to know the length of steel bars to be purchased at any one time.

This length is called “economic order quantity” and an economic order quantity is one which permits lowest cost per unit and is most advantages.

This can be calculated by the following formula:

Q = √2AS/I

Where Q stands for quantity per order

A stands for annual requirements of an item in terms of rupees

S stands for cost of placement of an order in rupees; and

I stand for inventory carrying cost per unit per year in rupees.

2. Inventory Models

Inventory models determine when and how inventory to carry.

(i) Inventory models handle chiefly two decisions:

• How much to order at one time.
• When to order this quantity to minimize total costs.

(ii) Lowest-cost decision rules for inventory management pertain to either buying products from outside or producing then within the company.

(iii) Single inventory models assume no delivery delay and that demand is known.

(iv) Probabilistic models handle situations of risks and uncertainty.

3. ABC Analysis

In order to exercise effective control over materials, A.B.C. (Always Better Control) method is of immense use. Under this method materials are classified into three categories in accordance with their respective values. Group ‘A’ constitutes costly items which may be only 10 to 20% of the total items but account for about 50% of the total value of the stores.

A greater degree of control is exercised to preserve these items. Group ‘B’ consists of items which constitutes 20 to 30% of the store items and represent about 30% of the total value of stores.

A reasonable degree of care may be taken in order to control these items. In the last category i.e. group ‘Q’ about 70 to 80% of the items is covered costing about 20% of the total value. This can be referred to as residuary category. A routine type of care may be taken in the case of third category.

This method is also known as ‘stock control according to value method’, ‘selective value approach’ and ‘proportional parts value approach’.

If this method is applied with care, it ensures considerable reduction in the storage expenses and it is also greatly helpful in preserving costly items.

4. Material Requirements Planning

MRP is a computational technique that converts the master schedule for end products into a detailed schedule for raw material and components used in the end products. The detailed schedule indentifies the quantities of each raw material and component items. It also tells when each item must be ordered and delivered so as to meet the master schedule for the final products.

5. VED Analysis

Vital essential and desirable analysis is used primarily for the control of spare parts. The spare parts can be divided into three categories:

(i) Vital

(ii) Essential

(iii) Desirable

(i) Vital: The spares the stock out of which even for a short time will stop production for quite some time and future the cost of stock out is very high are known as vital spares.

(ii) Essential: The spare stock out of which even for a few hours of days and cost of lost production is high is called essential.

(iii) Desirable: Spares are those which are needed but their absence for even a week or so will not lead to stoppage of production.

There are two basic methods of labour remuneration, i.e., time rate and piece rate system of wage payment. In modern days a number of incentive plans to induce workers to work hard so as to produce more and earn more are being used.

Method 1. Time Rate System:

Under this system of wage payment, workers are paid according to the time for which they work. Payment may be on hourly basis, daily basis, weakly basis, or monthly basis. In this system, no consideration is given to the quantity and quality of work done.

When payment is made on hourly basis, total wages payable are calculated as follows:

Wages = No. of hours worked x Rate per hour

For example – if a worker is paid at the rate of Rs. 7.50 per hour, his wages for a day of 8 hours will be 7.5 × 8 = Rs. 60.

Though this is the oldest system of wage payment, yet it is commonly used these days.

Suitability:

This method of wage payment is suitable under the following type of situations:

1. Where quality of work is more important than quantity of work (i.e., high class tailoring)
2. Where output cannot be measured in quantitative terms, e.g., in the case of indirect workers like watch man, cleaners and sweepers, etc.
3. Where output is beyond the control of the worker, e.g., in process industries, where the work of a worker is dependent on the work of other workers.
4. Where work is being done on a small scale so that close supervision is possible.
5. Where the worker is a learner or an apprentice.

Advantages:

Following are the main advantages of this method:

1. Simplicity:

The system is simple and calculation of wages is easily understood by the workers.

2. Security to Workers:

Under this method, workers are assured of a certain amount of wages payable even if there is stoppage of work due to power failure, machine break-down etc. This gives a sense of security to workers.

3. Quality of Work:

As this method does not give weight to the quantity of work done, workers can concentrate on the quality of goods produced. Thus, the quality of work under this method is better.

4. Economical:

Under this method, no detailed records are required to be maintained regarding the work done by workers. This results in saving of clerical costs. Moreover, workers avoid over-speeding and causeless damage to Plant and Machinery and also materials. This also results in economy.

5. Accepted by Trade Unions:

This method is favoured by trade unions because it treats all workers alike and no distinction is made between efficient and inefficient workers.

6. Unity in Labour:

No hard line of distinction is drawn between an efficient and inefficient worker on the basis of production. This promotes a feeling of unity among the workers.

Disadvantages:

The main disadvantages of this method are:

1. Lack of Incentive:

This method of wage payment offers no positive inducement to workers to improve performance as it does not distinguish between an efficient and inefficient workers.

2. Lower Production:

As workers are paid on time basis, they tend to be slow in work. This results in lower production quantity.

3. More Supervision:

Under this method, more supervision is required, so that workers may not waste time. Appointment of additional supervisors increases supervision costs.

4. Idle Time:

Under this method of wage payment, workers waste a lot of time resulting in increasing in idle time.

5. Costing Difficulties:

From costing point of view, it creates difficulties in the calculation of labour cost per unit because the output is quite fluctuating.

6. It Makes Workers Lazy and Dull:

Due to the adoption of this method, workers become lazy and dull and try to avoid work, and thus production suffers.

Method 2. Piece Wage System:

Under this method, workers are paid in proportion to the work done by them. The rate is fixed per unit of output, per article, per commodity, etc. The worker is paid for the total units manufactured. The system is thus is result oriented. For example, if the rate per unit is Rs. 5 and the worker manufacturers 100 units in a week, his week’s wages shall be Rs. 500 (i.e., 100 x 5).

It may be expressed in the form of the following formula:

Total earnings = Units Manufactured x Rate per unit

Suitability:

Conditions under which piece rate method of wage payment may be usefully employed are:

1. Where the output of workers can be measured.
2. Where production is standardised and repetitive in nature.
3. When the aim is continuous maximum production.
4. Where workers continue at the same job for a long period.
5. Where the standard time required to complete a job can be measured accurately.

Advantages:

Piece rate system has the following advantages:

1. Incentive to Efficient Workers:

Under this method, as remuneration is paid in proportion to the worker’s effort, the method provides a strong incentive to work move.

2. Increase in Production:

Under this method, each worker tries his best to produce more to earn higher wages. This results in increase in production.

3. Decrease in Supervision:

Under this method of wage payment, strict supervision is not required because the workers are themselves interested in maximising their earnings through the maximisation of output.

4. Equitable Wages:

This system is more equitable in comparison to time rate system because wages are paid according to the efficiency of each worker.

5. Simple and Easy:

This method is simple and easily understood by the workers.

6. Simplifies Costing:

As, under this method, wages are paid at a rate per unit, it simplifies cost ascertainment because labour cost per unit is known in advance.

7. Decreased Cost:

On account of increase in production, fixed cost per unit is reduced resulting in higher profit.

Disadvantages:

Piece rate system of wage payment suffers from the following demerits:

1. Lack of Secured Wages:

This system does not guarantee of minimum wage to a worker. If a worker is not able to complete his allotted work in a day, due to any reason, he is paid less amount of wages. Thus, under this method, earnings of workers are uncertain.

2. Inferior Quality of the Product:

Under this method, much emphasis is given on quantity of production and ignores quality of the product. In order to maximise their wages, workers try to produce more and more without caring for the quality of production.

3. Injurious to Health of Workers:

In an effort to earn more wages, workers try to work excessively with greater speed. This proves to injurious to health of workers.

4. Misuse of Equipment and Materials:

In the greed to produce more, workers cause extra wastage of material and damage plant and machinery.

5. Unsuitable in Certain Cases:

This method does not suit where work is of artistic and refined nature.

6. Difficulties in Fixing Piece Rate:

Fixing equitable piece rate is quite a difficult task and may require considerable amount of work in the form of time studies.

7. Opposed by Trade Unions:

Price rate system is generally opposed by trade unions because it creates inequality in the wages of workers. Slow and inefficient workers feel jealous of the higher of their follow workers.

Incentive Plans:

Both time rate system and piece rate system discussed above have their merits and demerits. Incentive plans attempt to combine the good points of both the systems.

The primary purpose of an incentive plan is to induce a worker to produce more to earn a higher wage. Naturally, producing more in the same period of time should result in higher wages for the workers. Because of greater number of units produced, it should also result in a lower cost per unit for fixed factory cost and also for labour cost.

Objectives of Incentive Plans:

The main objectives of incentives wage plans are:

1. To induce the workers to increase their productivity.
2. To provide additional remuneration to the workers to their efforts and efficiency.
3. To have a contented labour force, and to reduce the labour turnover.
4. To keep the morale of the workers high.
5. To have increased production from the improved productivity of the workers.
6. To have reduction in the fixed overhead cost per unit through increased production.

Suitability of the Plan:

Incentive wage plans are suitable in the following cases:

1. Those industries where proper time and motion studies can be undertaken and proper standards of time and output can be fixed.
2. Those industries where overhead charges are considerable and which can be reduced through increased production resulting from incentive schemes.

Essentials of a Good Incentive Plan:

A good incentive plan should contain certain essentials.

The essentials of a good incentive plan are:

1. For the successful implementation of an incentive plan, proper and accurate time and motion studies should be conducted and proper standards should be fixed.
2. The standard set for production should be such that any worker of normal efficiency can attain them.
3. The standards, on set, should not be changed unless there is a change in the method of production.
4. Job analysis and standardisation must be made on scientific and equitable basis.
5. Tools, equipment and machines must be maintained in efficient working condition.
6. Proper and comfortable working conditions should be provided to workers.
7. Uniform working conditions should be provided to all the workers.
8. Regular flow of materials and other supplies should be ensured.
9. Every worker should be given equal opportunity to earn.
10. The workers should be taught the proper way of doing the work.
11. The workers should not suffer on account of factors beyond their control, such as – break-down of machines, power failure, etc.
12. The incentive plan should be permanent and not temporary.
13. The plant should be flexible enough to permit changes to suit the changes in the method of work.
14. The plan should be easy for the workers to understand.
15. The workers should be properly educated about the scheme and motivated to improve their efficiency and earn more.
16. It should be economical to operate.
17. The plan should be acceptable to both employer and the employees.
18. The incentive provided should be sufficiently attractive.
19. There should be no maximum limit on the amount of earnings of the workers.
20. Indirect workers should also be included under the incentive scheme.
21. The scheme should have the approval of workers and the union.

Advantages of Incentive Plan:

Incentive wage schemes have the following advantages:

1. The workers are assured of their time rates or day rates of wages, whether they attain the standard or not.
2. In-efficiency is not penalised, as the workers are assured of their day rates of wages, whether they attain the standard or not.
3. Efficiency is rewarded, as the workers of higher efficiency are given bonus in addition to their time wages.
4. Incentive is given to workers to increase their productivity.
5. Opportunity is given to workers to increase their earnings by efficient work.
6. It keeps the labour force contented, and thereby, helps to reduce labour turnover.
7. The increase in production leads to reduction in cost per unit.
8. The gain or losses arising from the efficiency of the workers are shared by both the employer and the employees.

Disadvantages of Incentive Plan:

The incentive schemes are not without drawbacks. They suffer from several drawbacks.

Their main drawbacks are:

1. The incentive schemes cannot be gain-fully employed in concerns where the overheads are less.
2. These schemes cannot be adopted in undertakings where proper standards cannot be fixed.
3. It is difficult to calculate indirect labour under the common incentive schemes.
4. These schemes require careful determination of standard time and standard output which involves additional work and expenditure.
5. The bonus paid to workers under these schemes may not be proportionate to the improved efforts or productivity of the workers.
6. The quality of the product may suffer, because of their eagerness to save time and earn more.
7. Once an incentive scheme is introduced, it will be very difficult to withdraw that scheme later, it becomes uneconomical.

Cost Accounting is a business practice in which we record, examine, summarize, and study the company’s cost spent on any process, service, product or anything else in the organization. This helps the organization in cost controlling and making strategic planning and decision on improving cost efficiency. Such financial statements and ledgers give the management visibility on their cost information. Management gets the idea where they have to control the cost and where they have to increase more, which helps in creating a vision and future plan. There are different types of cost accounting such as marginal costing, activity-based costing, standard cost accounting, lean accounting. In this article, we will discuss more objectives, advantages, costing and meaning of costs.

Features of Cost Accounting

• It is a sub-field in accounting. It is the process of accounting for costs
• Provides data to management for decision making and budgeting for the future
• It helps to establish certain standard costs and budgets.
• provides costing data that helps in fixing prices of goods and services
• Is also a great tool to figure out the efficiency of a unit or a process. It can disclose wastage of time and resources

Types and Classification of Cost Accounting

• Activity Based Costing
• Lean Accounting
• Standard Accounting
• Marginal Costing

Standard Accounting

Standard costing is a technique where the firm compares the costs that were incurred for the production of the goods and the costs that should have been incurred for the same.

Marginal Costing

This type of costing is based on the principle of dividing all costs into fixed cost and variable cost.

Fixed costs are unrelated to the levels of production. As the name suggests these costs remain the same irrespective of the production quantities.

Variable costs change in relation to production levels. They are directly proportionate. The variable cost per unit, however, remains the same.

Importance and Objectives of Cost Accounting

• Classification of Cost
• Cost Control
• Price Determination
• Fixing of Standards

Advantages

• Measuring and Improving Efficiency
• Identification of Unprofitable Activities
• Fixing Prices
• Price Reduction
• Control over Stock
• Evaluates the Reasons for Losses
• Aids Future Planning

Nature

Helps in Decision Making: Cost accounting helps in decision making. It provides vital information necessary for decision making. For instance, cost accounting helps in deciding:

1. Whether to make a product buy a product?
2. Whether to accept or reject an export order?
3. How to utilize the scarce materials profitably?

Helps in fixing prices: Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis information for the preparation of tenders, estimates and quotations.

Formulation of future plans: Cost accounting is not a post-mortem examination. It is a system of foresight. On the basis of past experience, it helps in the formulation of definite future plans in quantitative terms. Budgets are prepared and they give direction to the enterprise.

Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By appropriate control measures, these wastages can be avoided or minimized.

Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting. For instance, it is possible for the management to know whether the profits have decreased due to an increase in labour cost or material cost or both.

Reward to efficiency: Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the organization. These plans and systems reward efficient workers and improve productivity as well improve the morale of the work -force.

Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control and standard costing. Scope for manipulation and fraud is minimized.

Improvement in profitability: Cost accounting reveals unprofitable products and activities. Management can drop those products and eliminate unprofitable activities. The resources released from unprofitable products can be used to improve the profitability of the business.

Preparation of final accounts: Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit and loss account and balance sheet without physical stock verification.

Facilitates control: Cost accounting includes effective tools such as inventory control, budgetary control and variance analysis. By adopting them, the management can notice the deviation from the plans. Remedial action can be taken quickly.

 Scope

The term scope here refers to field of activity. Cost accounting refers to the process of determining the cost of a particular product or activity. It provides useful data both for internal and external reports reporting. Internal reporting presents details of cost data in a summarized and aggregate form. For instance, in case a company manufacturing electrical goods cost of each product.

In order that cost accounting satisfies the requirements of both internal and external reporting, the following are the different activities which are undertaken under cost accounting system:

Cost Determination: This is the first step in the cost accounting system. It refers to determining the cost for a specific product or activity. This is a critical activity since the other three activities, explained below, depend on it.

Cost Recording: It is concerned with recording of costs in the cost journal and their subsequent posting to the ledger. Cost recording may be done according to integral or non-integral system a separate set of books is maintained for costing and financial transactions.

Cost Analyzing: It is concerned with critical evaluation of cost information to assist the management in planning and controlling the business activates. Meaningful cost analysis depends largely upon the clear understanding of the cost finding methods used in cost accounting.

Cost Reporting: It is concerned with reporting cost data both for internal and external reporting purpose. In order to use cost information intelligently it is necessary for the managers to have good understanding of different cost accounting concepts.

Limitations

In spite of the various advantages claimed by cost accounting, the discipline suffers from the following limitations:

Cost Accounting is costly to operate: It involves heavy expenditure to operate. The benefits derived by operating the system are more than the cost.

Cost Accounting involves many forms and statements: It involves usage of many forms and statements which leads to increase of paper work.

Costing may not be applicable in all types of Industries: Existing methods of cost accounting may not be applicable in all types of industries. Cost accounting methods can be devised for all types of industries, and services.

It is based on Estimations: Costing system relies on predetermined data and therefore it is not reliable. Costing system estimates costs scientifically based on past and present situations and with suitable modifications for the future. This leads to accurate cost figures based on which management can initiate decisions. But for the predetermined costs, cost accounting also becomes another ‘Historical Accounting’.

It is not an exact science: Like any others accounting system, it is not an exact science but an art that has developed through theories and practices.

Bias Judgments: Many judgments are biased and depend on individual discretion.

Difference in opinion: Different views are held by different cost accounts about the items to be includes in cost.