NAME OF INSTITUTION: H.R.

College of
Commerce and Economics

Topic: LABOUR COST

SUBJECT: FINANCIAL ACCOUNTING

AND COST- AUDITING

Name: samyak patwA

Class : s.Y. B.COM
Division : G
Roll Number : HSBC0938
 Financial Accounting Vs. Cost
Accounting
Cost Accounting Financial Accounting
Definition
Cost accounting is referred to as a form Financial accounting is a branch of
of managerial accounting that is used by accounting that is concerned with the
businesses to classify, summarize and summarizing, recording and reporting
analyse the different costs with the of financial transactions that take place
purpose of cost control and cost in a business concern over a time
reduction and thereby helping period.
management in making better decisions.
Type of Information documented
Documents the data associated with the Documents the data that are in
labour and material which are utilised in monetary terms.
the manufacturing procedure.
Estimation of Stock
Stock value is estimated at cost Stock value is estimated based on the
lesser value between net realisable
value or Cost
Analysis of Profit
Normally, the gains are investigated for a Profits, Income and expenditure are
specified job, batch, product and investigated together for a specific
procedure period of the entire trading concern
Primary Objective
Controlling and reducing cost Towards maintaining the complete
record of the financial transactions

Objectives and Functions of Cost Accounting:

1. To ascertain the cost per unit of the different products manufactured by a
business concern.
2. To provide a correct analysis of cost both by process or operations and by
different elements of cost.
3. To disclose sources of wastage whether of material, time or expense or in the
use of machinery, equipment and tools and to prepare such reports which may
be necessary to control such wastage.
4. To provide requisite data and serve as a guide for fixing prices of products
manufactured or services rendered.
5. To ascertain the profitability of each of the products and advise management as
to how these profits can be maximized.
6. To exercise effective control if stocks of raw materials, work-in-progress,
consumable stores and finished goods in order to minimize the capital locked
up in these stocks.
7. To reveal sources of economy by installing and implementing a system of cost
control for materials, labour and overheads.
8. To advise management on future expansion policies and proposed capital
projects.
9. To present and interpret data for management planning, evaluation of
performance and control.
10.To help in the preparation of budgets and implementation of budgetary control.
11.To organize an effective information system so that different levels of
management may get the required information at the right time in right form for
carrying out their individual responsibilities in an efficient manner.
12.To guide management in the formulation and implementation of incentive
bonus plans based on productivity and cost savings.
13.To supply useful data to management for taking various financial decisions
such as introduction of new products, replacement of labour by machine etc.
14.To help in supervising the working of punched card accounting or data
processing through computers.

Scope of Cost Accountancy

The scope of Cost Accountancy is very
wide and includes the following:-
(a) Cost Ascertainment: The main
objective of Cost Accounting is to find
out the Cost of product
/ services rendered with reasonable degree
of accuracy.
(b) Cost Accounting: It is the process of
Accounting for Cost which begins with
recording of
expenditure and ends with preparation of
statistical data.
(c) Cost Control: It is the process of
regulating the action so as to keep the
element of cost
within the set parameters.
(d) Cost Reports: This is the ultimate
function of Cost Accounting. These
reports are primarily
prepared for use by the management at
different levels. Cost reports helps in
planning and
control, performance appraisal and
managerial decision making.
(e) Cost Audit: Cost Audit is the
verification of correctness of Cost
Accounts and check on the
adherence to the Cost Accounting plan.
Its purpose is not only to ensure the
arithmetic accuracy
of cost records but also to see the
principles and rules have been applied
correctly.
To appreciate fully the objectives and
scope of Cost Accounting, it would be
useful to examine
the position of Cost Accounting in the
broader field of general accounting and
other sciences. i.e
Financial Accounting, Management
Accounting, Engineering and Service
Industry
The scope of Cost Accountancy is very
wide and includes the following:-
(a) Cost Ascertainment: The main
objective of Cost Accounting is to find
out the Cost of product
/ services rendered with reasonable degree
of accuracy.
(b) Cost Accounting: It is the process of
Accounting for Cost which begins with
recording of
expenditure and ends with preparation of
statistical data.
(c) Cost Control: It is the process of
regulating the action so as to keep the
element of cost
within the set parameters.
(d) Cost Reports: This is the ultimate
function of Cost Accounting. These
reports are primarily
prepared for use by the management at
different levels. Cost reports helps in
planning and
control, performance appraisal and
managerial decision making.
(e) Cost Audit: Cost Audit is the
verification of correctness of Cost
Accounts and check on the
adherence to the Cost Accounting plan.
Its purpose is not only to ensure the
arithmetic accuracy
of cost records but also to see the
principles and rules have been applied
correctly.
To appreciate fully the objectives and
scope of Cost Accounting, it would be
useful to examine
the position of Cost Accounting in the
broader field of general accounting and
other sciences. i.e
Financial Accounting, Management
Accounting, Engineering and Service
Industry
The scope of Cost Accountancy is very wide and includes the following:-
(a) Cost Ascertainment: The main objective of Cost Accounting is to find out
the Cost of product / services rendered with reasonable degree of accuracy.
(b) Cost Accounting: It is the process of Accounting for Cost which begins
with recording of expenditure and ends with preparation of statistical data.
(c) Cost Control: It is the process of regulating the action so as to keep the
element of cost within the set parameters.
(d) Cost Reports: This is the ultimate function of Cost Accounting. These
reports are primarily prepared for use by the management at different levels.
Cost reports helps in planning and control, performance appraisal and
managerial decision making.
(e) Cost Audit: Cost Audit is the verification of correctness of Cost Accounts
and check on the adherence to the Cost Accounting plan. Its purpose is not only
to ensure the arithmetic accuracy of cost records but also to see the principles
and rules have been applied correctly. To appreciate fully the objectives and
scope of Cost Accounting, it would be useful to examine the position of Cost
Accounting in the broader field of general accounting and other sciences. i.e
Financial Accounting, Management Accounting, Engineering and Service
Industry

The scope of Cost Accountancy is very

wide and includes the following:-
 (a) Cost Ascertainment: The main
objective of Cost Accounting is to find
out the Cost of product
/ services rendered with reasonable degree
of accuracy.
(b) Cost Accounting: It is the process of
Accounting for Cost which begins with
recording of
expenditure and ends with preparation of
statistical data.
(c) Cost Control: It is the process of
regulating the action so as to keep the
element of cost
within the set parameters.
(d) Cost Reports: This is the ultimate
function of Cost Accounting. These
reports are primarily
prepared for use by the management at
different levels. Cost reports helps in
planning and
control, performance appraisal and
managerial decision making.
(e) Cost Audit: Cost Audit is the
verification of correctness of Cost
Accounts and check on the
adherence to the Cost Accounting plan.
Its purpose is not only to ensure the
arithmetic accuracy
of cost records but also to see the
principles and rules have been applied
correctly.
To appreciate fully the objectives and
scope of Cost Accounting, it would be
useful to examine
the position of Cost Accounting in the
broader field of general accounting and
other sciences. i.e
Financial Accounting, Management
Accounting, Engineering and Service
Industry
 Elements of Cost
Material Cost

Material cost refers to the commodities supplied to an undertaking, such as the cost
of yarn and dyes engaged in manufacturing cloth.

Further subdivisions of material costs include:

(a) Direct material cost: The cost of materials identifiable with and allocated to
cost centers or cost units, such as the cost of wood in the case of furniture. Direct
materials enter into and form part of the finished product.

(b) Indirect material cost: The material cost that cannot be allocated but can be
apportioned to or absorbed by cost centers or cost units. These materials cannot be
traced as part of the product, and their cost is distributed among the cost centers or
cost units on an equitable basis.

Labor Cost (or Wages)

The cost of remunerating the employees of an undertaking, e.g., wages, salaries,

and commission.

Further subdivisions include:

(a) Direct labor cost (or direct wages): The labor cost identifiable with and
allocated to cost centers or cost units.

Direct labor cost includes the remuneration paid to convert raw materials into
finished products or alter the construction, composition, or condition of the product
manufactured by an undertaking.

Direct labor cost also includes the wages paid to those who directly carry out or
operate a service, such as a driver and conductor of a bus in the transport business.

(b) Indirect labor cost (or indirect wages): The labor cost or wages that cannot
be allocated but can be apportioned to or absorbed by cost centers or cost units,
such as the salary paid to a factory manager.

Expenses

The cost of services provided to an undertaking and the notional cost of using
owned assets (i.e., depreciation of an owned factory building).

Subdivisions of expenses include:

(a) Direct expenses (or chargeable expenses): The expenses (other than direct
material cost and direct labor cost) identifiable with and allocated to cost centers or
cost units.

One example is octroi paid on the purchases of imported direct materials (if not
added to their purchase price).

(b) Indirect expenses: Expenses that cannot be allocated but can be apportioned to
or absorbed by cost centers or cost units, such as rent, rates, taxes, insurance of the
factory building, factory lighting, repairs, and so forth.

The aggregated direct material cost, direct labor cost, and direct expenses result in
the direct cost. The aggregated indirect material cost, indirect labor cost, and
indirect expenses are known as the indirect cost or overhead, which can be
classified into:
(i) Factory overhead or works overhead: All the indirect costs incurred in
manufacturing operations: indirect materials, indirect labor, and all other indirect
expenses, such as wages, factory rent, factory rates, repairs, and so forth.

(ii) Office and administration overhead: All the indirect costs relating to the
direction, control, and administration of an undertaking, such as office rent and
staff salaries.

(iii) Selling and distribution overhead: All indirect costs incurred for promoting
sales, retaining customers, and delivering goods after their manufacture, such as
advertising, salesmen salaries, commission on sales, carriage on sales, and packing
charges.

Labour Cost
Labour cost: cost of wages & other benefits paid by employer to workers on the
basis of time/putput produced using physical/mental exertion.

■ Direct Labour is the cost of that labour which is expended in altering the
construction, composition or condition of the product.

■ Indirect Labour cost is the wages paid to those workers who are not directly
engaged in converting raw materials into finished products.

OVERTIME
Work done beyond normal working hours is known as ‘overtime work’. Overtime
payment is the amount of wages paid for working beyond normal working hours.
Overtime payment consist of two elements-

(i) Normal wages for overtime work and

(ii) Premium payment for overtime work.

Overtime premium: The rate for overtime work is higher than the normal time rate;
usually it is at double the normal rates. The extra amount so paid over the normal
rate is called overtime premium.
 Rate and conditions for overtime premium may either be fixed by an entity itself
or it may be required by any statute in force. The overtime premium should not be
less than the premium calculated as per the statute.

However, overtime work may be avoided, because:

1. When a worker, after his normal hours of work is asked to do overtime, the
quality of the output is affected.

2. Double rate has to be given (a loss to the firm).

3.Overhead expenses will also increase.

Idle time
When workers spent their whole time at different jobs, then the time booked for
jobs must with the gate time. Ordinarily the time booked for jobs does not agree
with the gate time. It so happens, because of reasons like, waiting for materials,
machine breakdown, waiting for instruction, power failure etc. Reconciliation of
gate time with time booked is facilitated by preparing an idle time card.

Idle time arises because of:

(i) Power failure

(ii) Waiting for work

(iii) Waiting for instruction

(iv) Waiting for tools

(v) Machine breakdown

(vi) Bad Planning of work

(vii) Accidents, strikes etc.

(viii) Time wasted in changing from one job to another

(ix) Season nature of industry

(x) Time taken to reach the department, from gate

Remuneration and Incentives

Total wages earned by the employees is termed as remuneration. Time wages or

piece wages earned plus other financial incentives constitute the earning of
employees. Productivity depends mainly on labour and, other things like better
equipment, production planning are contributory factors to higher productivity
Good wage system along with effective incentive system will encourage the labour
force to give their best to the employer.

More over attractive ‘pay package’ will reduce labour turnover. In addition to
monetary incentives non-monetary incentives also encourage employees to
improve their productivity. Non-monetary incentives include, promotional
opportunities training schemes, etc. The remuneration system should serve the twin
objectives of reducing the labour cost and at the same time the workers are to be
compensated adequately for their work.

Methods of Remuneration:
There are two basic methods of wage payment:
(i) Payment made on the basis of time spent by the workers in the factory
irrespective of output produced.

(ii) Payment of wages on the basis of production or work done irrespective of time
taken by the worker.
The methods of wage payment are respectively called time wages and piece wages.

1. Time rate system:

Under this method the workers are paid on he basis of hourly daily, weekly or
monthly rate.

There are five variations of time wages which are as follows:

i. Flat Time Rate:
Under this method workers are paid at a single rate on the basis of the time they are
employed. The flat rate may be per hour, per day or per week or on monthly basis.
The earnings of employees depend on total time they spend in the factory. The flat
rate id decided on the basis of rates prevailing in the locality where the industry is
situated. This flat rate is suitable for highly skilled workers, unskilled workers and
apprentices.

It is suitable is the under mentioned types of work:

(a) Where high quality goods are being produced

(b) Where production is mechanized and involves high speed.

(c) Situations where output cannot be measured.

(d) Where effective and close supervision is possible.

(e) Where incentive schemes cannot be introduced as the workers may not be
directly involved with the final output.

To conclude the flat time rate does not recognize effort and it is not helpful in
increasing output.

ii. High Day Rate:

This method is introduced to attract skilled workers by offering the highest wages
in the industry. This method also intends to remove the draw backs of flat time rate
which does not provide incentive from efficiency. High rate is paid to employees
to achieve present targets of output.

The target or standard output fixed is at high level which only a skilled worker can
achieve. When high rate of wages are paid, overtime work is not permitted. High
day rate reduces the labour cost and over-head cost per unit with the help of high
output. This method will be successful only if efficient workers cooperate in
achieving high standards of output.

iii. Measured Day Rate:

Under this method of time wages the workers are given a particular work to be
performed and the rate is fixed on the basis of the level of performance of specified
work. This gives incentive to workers to get paid at high rate for high performance.
The main drawback of measured day rate is that the workers are not paid any
additional remuneration for any improvement in the level of performance
originally specified.

iv. Graduated Time Rate:

Under this method the wage rate is fixed by linking it with cost of living index.
The rate of wages goes on changing with change in cost of living index. During the
period of rising prices the workers find it helpful as they are compensated for
increased prices.

v. Differential Time Rate:

This method recognizes individual efficiency and skill. The workers in the same
group will be paid at different rates. High rates are paid for efficient workers and
lower rates are paid for inefficient workers. There is positive incentive offered for
improvement of performance.

2. Piece Rate System:

This is also called ‘payment by results’. The workers are paid on the basis of
output produced by them. The earnings of the workers depend on the number of
units of output produced and the wage rate per unit received by the worker. The
payment by results system is successful only if the work is of repetitive nature.

The effect of piece rate is that the remuneration is at constant rate and labour cost
per unit remains stable throughout the range of output. The total cost per unit
decreases considerably on account of reduction in the fixed overhead per unit for
increased volume of production.

Variation of Piece Wages:

There are four variations of piece wages.
They are as under:
(I) Straight Piece Rate System:
Under straight piece rate system workers are paid according to the number of units
produced at a fixed rate per unit.

(II) Differential Piece Rates:

This is an improvement over straight piece rate to increase the performance of both
efficient and inefficient workers. Two or more rates are offered to workers. Higher
performance is paid at a higher rate and lower performance is paid at lower piece
rate. In other words the increase in wages is in proportion to increase in
production.

There are three types of differential piece rates:

A. Taylor’s Differential Piece Rate System:
The ‘Father of Scientific Management’ F.W. Taylor has introduced this method.

There are two different piece rates applicable to the workers:

(a) Lower piece rate for the workers with below standard performance. The lower
piece rate applicable is 80% of straight piece rate.

(b) Higher piece rate for the work with performance above the standard or at the
standard. The higher piece rate applicable is 120% of straight piece rate.

B. Merrick’s Multiple or Differential Piece Rate System:

This method is an improvement over Taylor’s method. This method has three rates
for different level of performance. Wages are paid at ordinary piece rate to those
workers whose performance is less than 83% of standard output; 110% of the
ordinary piece rate is given to workers whose level of performance is between 83%
and 100% of the standard and 120% of the ordinary piece rate is given to workers
who produce more than 100% of the standard output.

C. Gantt’s Task and Bonus Plan:

Under this method a standard time is fixed for a task to be performed by workers.
Actual time taken is compared with the standard time and efficiency is ascertained.

(1) Time wage are paid to the workers whose performance is below 100%, i.e.,
those who take more than the standard time.
(2) Time wages and 20% of time wages as bonus are paid to those workers who
take standard time to complete the job (whose performance is at 100%)

(3) Wages at high piece rate on the whole output are paid to the workers who take
less than standard time (whose efficiency is above 100%).

Some authors have provided for 20% bonus over and above high piece rate for
above standard workers. But an overwhelming majority of authorities concur with
the rates given above and are used here.

Premium Bonus Schemes:

Premium plans are introduced to enhance the individual performance of workers.
The workers are induced to show efficiency by performance of job in less than the
standard time.

Under the premium plans, a standard time is fixed for a specific job or operation
and the worker is paid for the actual time taken by him at hourly rate plus wages
for a portion of the time saved as bonus. “A premium and bonus plan” is called
“incentive plan” because the worker is provided incentive to earn more wages by
completing the work in less time.

A. Premium Bonus Systems:

The following are some of the popular monetary premium bonus systems:
i. The Halsey premium plan:
This system is known as fifty fifty plan. It was introduced by F.A. Halsey, an
American engineer. Under this method a standard time is fixed for the performance
of each job; worker is paid for actual time taken at an hourly rate plus 50% of time
saved as bonus;

Total earnings

= Hours worked × Rate per hour + (5C/100) Time saved × Rate per hour

= T × R + 50% (S-T)R

iii. Rowan System or Rowan Plan:

The scheme was introduced in 1901 by David Rowan of Glasgow, England. The
wages are calculated on the basis of hours worked whereas the ‘bonus is that
proportion of the wages of time taken which the time saved bears to the standard
time allowed’.

Total Earnings under Rowan plan

Group Bonus Systems:

Premium bonus schemes are meant for individual incentive where their output can
be measured. In some cases individual output cannot be measured. Under such
circumstances group bonus schemes take the place of individual bonus plans. The
total bonus can be shared between workers of different skills in different specified
proportions, the latter being commonly based on the individual time rates although
agreed percentage allocations may be used.

The main group bonus schemes are:

(i) Budgeted expenses bonus,

(ii) Cost efficiency bonus,

(iii) Priest may system

(iv) Towne’s Gain sharing system and

(v) Waste reduction scheme.

 Labour Turnover:
Labour turnover may be defined as change in labour force i.e., percentage change
in the labour force during a specific period. High labour turnover indicates that
labour is not stabilised and there are frequent changes by way of workers leaving
the organization. High labour turnover is to be avoided. At the same time very low
labour turnover indicates inefficient workers are being retained in the organization.

Methods of Measurement of Labour Turnover:

There are three methods of measuring labour turnover which are explained
below:
(i) Labour Turnover under Separation Method:
The basis of calculating labour turnover under this method is the number of
employees discharged during a period. It does not consider surplus labour being
discharged by the firm (retrenchment).

(ii) Labour Turnover under Replacement Method:

The number of employees recruited during a period is taken as basis for calculating
labour turnover. This does not consider expansion programmes.

(iii) Labour Turnover under Flux Method:

This method takes into account the number of employees who left the organization
and those recruited by the organization during a period.
Causes of Labour Turnover:
The causes for labour turnover can be broadly classified under three heads:
(i) Personal Causes:
Some of the employees may leave the organization on account of personal
reasons as given below:
(a) Circumstances of family.

(b) Retirement on reaching the prescribed age.

(c) Change in material status in case of women employees.

(d) Dislike for the job or place.

(e) Death of the employee.

(f) Employee getting recruited in a better job.

(g) Permanent disability due to accidents.

(h) Involvement of employee in activities of moral turpitude.

(ii) Unavoidable Causes:

In certain instances the organization may discharge the employees due to
unavoidable reasons as mentioned below:
(a) Termination of workers on account of insubordination or inefficiency.

(b) Discharge of workers on account of irregularity or long absence.

(c) Retrenchment of workers by the company on account of shortage of work.

(iii) Avoidable Causes:

Some of the employees may leave the organization account of the following
reasons:
(a) Non availability of promotion opportunities.

(b) Dissatisfaction with incentive schemes.

(c) Unhappy with remuneration

(d) Unsuitable to job due to wrong placement

(e) Unhappy with working conditions

(f) Non availability of accommodation, health and recreational facilities

(g) Lack of stability of Tenure.