COST ACCOUNTING

Accounting for Labor

Learning Objectives:
1. Distinguish between features of hourly rate and piece-rate plans
2. Specify procedures for controlling labor costs
3. Account for labor costs and payroll taxes
4. Prepare accruals for payroll earnings and taxes

ACCOUNTING FOR LABOR

Labor is the physical or mental effort expended to convert raw materials into finished products.
Labor cost is the price paid for using human resources. Labor may be either direct or indirect. Direct labor
is easily traced to the product and is a major cost of producing the finished goods, and can be identified
directly with the processing of the product. Indirect labor includes all other labor cost related to the
conversion of raw materials into finished goods such as salary of timekeeper or supervisor, overtime
premium, employer’s share of direct laborer’s SSS, Philhealth, pag-Ibig premiums, vacation and sick leave
pay and other fringe benefits of direct labourers. Wages are payments made on an hourly, daily or
piecework basis. Salaries are fixed payments for managerial services.

Other terms used in accounting for labor:

GROSS EARNINGS = Regular wages + overtime premium

REGULAR WAGE = Total hours worked (including overtime) x regular hourly rate
OVERTIME PREMIUM = Overtime hours worked x extra hourly compensation for overtime

FACTORY PAYROLL
1. Direct Labor represents payroll costs traced directly to an individual job
2. Indirect Labor – consists of labor costs incurred for a variety of jobs related to the production
process but not readily traceable to the individual jobs worked on during the period. It includes the
salaries and wages of factory superintendent, supervisors, janitors, clerks and factory accountants
who support all jobs worked on during the period.

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 involved computing and recording employee gross earnings,
withholding taxes and deductions and net earnings.
Wage Plans
1. Hourly Rate Plan – establishes a definite rate per hour for each employee. An employees’ wages
are computed by multiplying the number of hours worked in the payroll period by the established
rate per hour.
2. Piece-Rate Plan – a company that gives priority to the quantity produced by each worker should
consider using an incentive wage plan such as a piece-rate plan, which bases earnings on the
employee’s quantity of production.
3. Modified Wage Plan – combines some features of the hourly rate and piece-rate plans. An example
of a modified wage plan would be to set a base hourly wage that will be paid by the company even
if an employee does not attain an established quota of production. If established quota is exceeded,
an additional payment per piece would be added to the wage base.

Journal Entry to record Payroll

a. Journal entry to record payroll for the period

Payroll xxx
Withholding Taxes Payable xxx
SSS Premiums Payable xxx
Philhealth Premiums Payable xxx
Pag-Ibig Premiums Payable xxx

b. Journal entry to record overtime premium

Work in Process xxx

Factory Overhead – overtime premium xxx
Payroll xxx

c. Journal entry to distribute payroll

Work in Process Inventory xxx

Factory Overhead – Indirect Labor xxx
Selling Expenses xxx
General Expenses xxx
Payroll xxx

LABOR RELATED COSTS

Aside from the regular daily or hourly rates or piecework rate, factory workers are given additional
incentives to encourage them to improve their output and quality of work. These labor related incentives
are in the form of overtime premium (should be in accordance with labor law) shift premium, bonus,
vacation and holiday pay, SSS, Philhealth, Pag-Ibig premium contributions of the employer and other
incentive plans. These extra pay given to factory workers even if they are direct labourers are accounted
for as factory overhead.
Overtime Premium

An employee worked 45 hours this week. His regular wage is P 20 per hour and he is paid time and a half
for overtime hours. (hours beyond 40 per week)
Regular wage [P20/hr] (40 x P 20) P 800
Overtime Wage ( 5 x P 20) 100
Overtime Premium [P 10/hr] (5 x P 10) 50

Journal entry:

1. Charged to Specific Job – if the job is taken as a rush order with the knowledge that overtime
will be necessary.

Work in Process 950

Payroll 950

2. Charged to factory overhead. When the regular orders cannot be completed in the regular
working hours, the overtime premium should be charged to factory overhead

Work in Process 900

Factory Overhead Control – Overtime premium 50
Payroll 950

Shift Premium or Differential

Often, an above normal wage is paid for undesirable shifts like night shifts. Like the overtime
premium this extra premium is charged to Factory Overhead. Employees who work during the day are paid
P 20 per hour. Those who work nights are paid P 22 per hour. All employees work 40 hours per week. To
record the weekly wages for one night shift employee.
Regular wage [P20/hr] ( 40 x P20) P 800
Night Wage [P22/hr]
Shift Premium [P2/hr] (40 x P 2) 80

Work in Process (Labor) 800

Factory Overhead Control – shift Premium 80
Payroll 880

Bonus
A bonus is additional compensation generally given in recognition of exceptional productivity.
Bonuses may be a set amount, a percentage of profits, or a percentage of an employee’s salary.
Theoretically, a bonus is a direct cost of production. However, because the purpose of cost accumulation is
the establishment of a standard unit cost, bonuses are charged to factory overhead. Ideally, a bonus should
be charged to a liability each week the eligible employee works. In practice, this can rarely be done so a
single entry at the end of a period is made.
Example. Each employee is entitled to a bonus of 1% of the company’s prior year’s profits. Assume that
the weekly pay is P 500, profits of prior year were P 260,000 to record the wages for the week including
the accrual of bonus.
Bonus (1% x P 260,000) P 2,600
Bonus per week (P2,600 /52 weeks) P 50

To record the weekly pay including the bonus, the entry will be

Work in Process – labor P 500

Factory Overhead – Bonus 50
Payroll P 500
Bonus Payable 50

Vacation and Holiday Pay

After a certain length of service, an employee receives paid vacation and holidays. Compensation
of this sort is called non-production pay because an employee is receiving wages while making no
contribution to output. Vacation and holiday pay are charged to factory overhead. As a result, charges
each week for service together with a portion of vacation pay can be made.

Sample. Joy has worked for X Manufacturing Co. for five years and is therefore entitled to two weeks
vacation with pay. Her weekly pay is P 6,000. The computation and journal entry to accrue Joy’s vacation
pay for the week, assuming that she is not on vacation now will be
Total Vacation Pay (P 6,000 x 2) P 12,000
Weeks over which vacation pay is accrued: 52 weeks – 2 weeks = 50 weeks
Weekly accrual = P 12,000/50 = P 240 per week

Journal Entry:

Work in Process – Labor P 6,000

Factory Overhead Control – Vacation Pay 240
Payroll P 6,000
Vacation Leave Payable 240

Fringe Costs
Wages and salaries plus any fringe benefits constitute employer’s payroll expense. Other common
fringe costs are SSS, Philhealth and Pag-Ibig Premiums

Journal Entry:
Factory Overhead – Fringe Costs xxx
SSS Premiums Payable xxx
Philhealth Premiums Payable xxx
Pag-Ibig Contributions Payable xxx
Incentive Plans
Some companies adopt incentive plans to encourage increases in production. Employees are not
penalized for producing less than the specified amount but are paid for extra for producing more. Wages
paid but not earned on a piecework basis are charged to factory overhead.

Sample:
X Company manufactures ladies bags. The average weekly salary is P 1,000 per week. To increase
production, the company adopted an incentive plan. The piecework rate per bag is P 50. Any employee who
produces fewer than 20 bags per week will still receive his or her original pay. Production above this amount
will earn the employee P 50 for each additional bag. One week after the plan was implemented, the
following data were collected.

Employees Bags Produced Wages Paid

Juan 20 P 1,000
Boy 22 P 1,100
Edgar 19 P 1,000
Maria 23 P 1,150

Juan : 20 x P 50 = P 1,000 no adjustment is made

Boy : 22 x P 50 = P 1,100 entire amount is direct labor
Edgar : 19 x P 50 = P 950 is direct labor and P 50 is factory overhead
Maria : 23 x P 50 = P 1,150 entire amount is direct labor

Journal Entry:
Work In Process – Labor P 4,200
Factory Overhead Control – Incentives 50
Payroll P 4,250