Chapter 3 Summary

Accounting for Labor

Factory payroll costs divided into direct and indirect labor

a) Direct labor, also known as touch labor, are payroll costs directly traced to an individual job

-Who physically transform raw materials into finished products

-Direct Labor is debited to Work Process

b) Indirect labor include the salaries and wages of the factory superintendent, supervisors, janitors,
clerks, and factory accountants

-who support all jobs worked on during the period

-Indirect Labor is charged to Factory Overhead

Additional (optional)

(You may also think of the distinction between direct labor and indirect labor relative to service firms.
For example, auditors with a public accounting firm would be considered direct labor relative to the
individual jobs that they worked on, whereas the salary of the managing partner would be indirect labor
that should be allocated to all of the clients audited in determining the total cost of servicing clients.
Other examples of indirect labor in an accounting firm would include the human resources function, the
technical support staff, and the secretarial function.)

The accounting system of a manufacturer must include the following procedures for recording payroll
costs:

1. Recording the hours worked or quantity of output by employees in total and by job, process, or
department.

2. Analyzing the hours worked by employees to determine how labor time is to be charged.

3. Charging payroll costs to jobs, processes, departments, and factory overhead accounts.

4. Preparing the payroll, which involves computing and recording employee gross earnings, withholdings
and deductions, and net earnings.

WAGE PLAN

Employees’ wages are based on plans that have been established by management, approved by the
unions, if present, and that comply with the regulations of governmental agencies. A manufacturer may
use many variations of wage plans.
Hourly Rate Plan

A definite rate per hour for each employee

Wages are computed by multiplying the no. of hours worked in the period by the rate per hour

Is widely used, simply to apply

Critics argue that it provides no incentive for the employee achieve high level of productivity

Employee is paid for being on the job

Gives no extra recognition or reward for doing more than the minimum required

Proponents of the plan argues back that productivity is not an important factor

Employees will not be tempted to sacrifice the quality of the product by speeding up production to earn
a higher wage.

Productivity

Measured as the amount of output per hour of work

Piece-Rate Plan

Based earnings on the employee’s quantity of production

Company that gives a high priority to the quantity produced by each worker should consider using an
incentive wage plan

Provides an incentive for employees to produce a high level of output, thereby maximizing their
earnings and also increasing the company’s revenue.

Shortcomings of the plan

May encourage employees to sacrifice quality to maximize earnings, unless the plan is based on only the
production of good units

Not appropriate if machines, rather than people, control production speed

Modified Wage Plan

Combination of some features of hourly rate and piece-rate plans

Set a base hourly wage that the company will pay if an employee does not attain an established quota of
production. (ex) If the established quota is exceeded, an additional payment per piece would be added
to the wage base.

This plan rewards high-performing employees and directs management’s attention to employees unable
to meet the established quotas.

Labor–management negotiations create many variations of the hourly rate and piece-rate plans. These
variations occur because management wishes to minimize costs and maximize profits, while labor
attempts to maximize employee earnings. (To illustrate a modified wage plan, assume that an employee
earns $15 per hour for up to 400 units of production per day. The employee who produces more than
400 units per day will receive an additional piece rate of $0.30 per unit. When the employee produces
fewer than 400 units, the difference, referred to as a make-up guarantee, will be charged to Factory
Overhead rather than to Work in Process because it represents the cost of inefficient production, rather
than a necessary cost of the specific jobs worked on.)

(If the number of pieces finished depends on a group effort, then a single incentive plan for the group
would be appropriate. In recent years, U.S. manufacturers have adopted the concept of production
work teams, where output is dependent on contributions made by all members of the work crew or
department. The wages may be computed in a manner similar to the previous illustration, except that all
members of the group would share the piece-rate bonus.)

Incentive compensation plans aren’t limited to manufacturing workers, but also to service businesses,
and managers/other employees participate in this plan.

CONTROLLING LABOR COSTS

Responsible for maintaining labor records are the timekeeping and payroll departments

Timekeeping and payroll functions may be established as separate departments or organized as

subdivisions of a single department. (Increasingly, automated timekeeping technology has replaced
‘‘timekeeping’’ as a separate department.)

(For example, many companies issue magnetic cards to direct laborers who use them to ‘‘log on’’ and
‘‘log off’’ to specific job assignments. They slide the card through a magnetic card reader connected to a
remote computer terminal, much as you would do to pay for your groceries at the supermarket. The
computer sends this labor time information to the accounting department for preparation of the payroll
and distribution of labor costs to the appropriate jobs.)

Payroll department within accounting department uses labor time records, electronically or manually, in
computing the gross earnings of employees, amounts of deductions and withholdings, and the net
earnings to be paid to the employee.
-Includes completing and maintaining the payroll records, the employee’s earnings records, and the
payroll summaries.

LABOR TIME RECORDS

Shows the employee’s time spent to each job as well as the time spent as indirect labor on machine
repair. (Given the magnetic card-reading technology mentioned earlier, the time record typically takes
the form of a computer file. Nonetheless, a production supervisor should review the labor hours
recorded on the time record for accuracy, because the time record is the source document for allocating
the cost of labor to jobs or departments in the job cost ledger and factory overhead ledger)

(The employer must compensate the employee for the time spent on assigned jobs. When time is not
fully utilized, the employer suffers a loss just as if a theft of some tangible good had occurred. Therefore,
if time spent in the factory has been unproductive, the idle time, along with the reason for it, should be
recorded and charged to Factory Overhead.)

PAYROLL FUNCTION

To compute the wages and salaries of employees is its primary responsibility

Involves combining the daily wages, determining the total earnings, and computing deductions and
withholdings for each employee

Payroll is often a function within a single accounting department, as opposed to being a separate
department

(he department must maintain current information concerning regulatory requirements regarding
wages and salaries because a specified amount of the employees’ wages are subject to social security
(FICA) and income tax deductions. Additional deductions, approved by the employee, can be taken for
group insurance premiums, union dues, contributions to a tax-sheltered annuity, and so on.)

Payroll Records

Forms used to record earnings information may vary considerably from company to company; however,
all forms possess some common characteristics

Note that the distribution of the gross payroll between Work in Process (for direct labor) and Factory
Overhead (for indirect labor) will be illustrated in the next section. Also note that a prior cash advance
was deducted from the paycheck this period, reducing the asset account Employee Receivable.)

Employees’ Earnings Records. In addition to the payroll record, payroll keeps a record of the earnings for
each employee. (This cumulative record of employee earnings is needed to compute the amount of
employee earnings subject to FICA and other payroll taxes. It also serves as the basis for reporting
payroll information to governmental agencies, such as individual employee earnings to the Social
Security Administration and Wage and Tax Statements (Form W-2) to employees for the purpose of
preparing their individual tax returns.)

Payment of Net Earnings. The accounting department sends the payroll record (Figure 3-3) to the
treasurer’s office, which is responsible for making the payments to the employees. The earnings usually
are paid by check.

REPORTING----------------------------------------------------------------------------------

ACCOUNTING FOR LABOR COSTS AND EMPLOYERS’ PAYROLL TAXES

(For all regular hourly employees, the hours worked should be recorded on a labor time record. The
payroll department enters pay rates and gross earnings and forwards the reports to accounting. Cost
accountants examine the labor time records and charge the labor costs to the appropriate jobs or
department and to factory overhead. This analysis of labor costs is recorded on a labor cost summary
(Figure 3-5) that summarizes the direct labor and indirect labor charges to a department for the period.)

Salaried employees, such as department supervisors, are often not required to prepare labor time
records. Payroll sends a list of salaried employees to accounting showing the names of employees, the
nature of work performed, and the salaries. The accounting department records the earnings on the
labor cost summary and in factory overhead ledger accounts, because the salaried factory employees
are supervisors and other factory managers who do not physically convert the raw materials to finished
goods, and therefore their salaries are indirect labor.
LABOR COSTS

1st Slide

Hours worked should be recorded on a labor time record for all regular hourly employees (except
salaried employees and factory managers, they often not required to prepare labor time records
because they do not physically convert the raw materials to finished goods, and therefore their salaries
are indirect labor.

The payroll department enters pay rates and gross earnings. It sends a list of salaried employees
showing their names, nature of work performed, and the salaries. Then, forwards the reports to
accounting department who records the earnings on the labor cost summary and factory overhead
ledger accounts

2nd

Figure 3-5 PICTURE

Labor cost summary is the analysis of labor costs which summarizes the direct and indirect labor charges
to a department for a period – becomes the source for making a general journal to distribute payroll to
the appropriate accounts

3rd

Work in Process xxxx

Factory Overhead xxxx

Payroll xxxx

Distribute payroll

Entry is posted to the control accounts in the general ledger. Labor time records is used to record labor
costs in both subsidiary job cost and factory overhead ledger, also in labor cost summary.

The debit to Work in Process control account must equal to total direct labor costs charged to individual
jobs.

The debit in Factory Overhead control accounts must equal to total indirect labor costs recorded in
factory overhead control account.

4th

Figure 3-6 Flow of costs from Subsidiary Records to General Ledger

PICTURE/FIGURE
5th

In preparing labor cost summary, overtime must be separated employee’s regular time because of the
different accounting treatment for each type of pay.

For regular time by direct laborer, it is charged to Work in Process. The overtime pay may be charged to
Work in Process, to Factory Overhead, or partly to Work in Process and partly to Factory Overhead.

6th

Overtime pay - the extra payment to the employee’s works beyond the regularly scheduled time but is
paid at regular hourly rate

Overtime premium – The additional rate earned for the extra hours worked

Premium pay rate is added for the additional hours worked

The premium rate is frequently one-half the regular rate, resulting in a total hourly rate for overtime
that is 150% of the regular rate. Under these circumstances, overtime pay is often referred to as ‘‘time-
and-a-half’’ pay. In some cases, such as work done on Sundays and holidays, the overtime premium may
be equal to the regular rate, resulting in ‘‘doubletime’’ pay.

7th

Assume that an employee earns $15 per hour for 8-hour day. If called upon to work more than 8 hours
in working day, company pays time-and-a-half for overtime hours.

Direct labor 8 hours @$15 xxx

Overtime wages:

Direct labor 4 hours xxx

Factory Overhead xxx xxx

Total Earnings xxx

EMPLOYERS’ PAYROLL TAXES

8th

Payroll Taxes imposed on employers include social security tax and federal and state unemployment
taxes
Employers must periodically report and pay taxes, if they fail to do so are subject to civil and criminal
penalties

The Federal Insurance Contributions Act (FICA)

-requires employers to pay social security taxes on wages and salaries equal to the amount withheld
from employees’ earnings.

- The employers and employees share equally in the cost of the social security program.

- includes a tax to finance the Federal Old Age, Survivors, and Disability Insurance program (OASDI) and
the Medicare program.

The legislation that governs FICA is frequently amended. These amendments change the wage base
subject to FICA and the percentage rate of tax to be charged.

The Federal Unemployment Tax Act (FUTA)

-requires employers to pay an established rate of tax on wages and salaries to provide for compensation
to employees if they are laid off from their regular employment.

State Unemployment Tax Payable (SUTA)

9th

Theoretically, employers’ payroll taxes should be charged in direct and indirect labor cost categories.
However, it is usually practical to record them in Factory Overhead due to additional expenses and time
such allocation is required.

Factory Overhead xxxx

FICA Tax Payable xxxx

Federal Unemployment Tax Payable xxxx

State Unemployment Tax Payable xxxx

Recognized payroll taxes

10th

Illustration of Accounting for Labor Costs