MATERIALS AND LABOUR COST

INVENTORY:

Inventories: inventories are assets:

 held for sale in the ordinary course of business - (finished products);

 in the process of production for such sale - (work in progress); or
 in the form of materials or supplies to be consumed in the production process or in the
rendering of services - (raw materials).

Valuation of inventory

Refers to the system of valuing inventory for the purpose of recording into the books and
provision of financial reporting.

SYSTEMS OF RECORDING INVENTORY:

Basically; there are two system of recording inventory

1. Periodic inventory system

2. Perpetual inventory system

Periodic inventory system: is a system of recording inventory that are used to value and
recording inventory in a specific period of time may be a weekly, monthly, semi-annually,
annually.

Perpetual inventory system: is the recording as they occur of receipts, issues and the resulting
balances of individual items of inventory in either quantity or quantity and value.

Inventory valuation is important for:

Financial reporting – for inclusion in the Financial statements of a business

Costing – to calculate how much to charge for a product based on the amount of inventory
consumed.

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METHODS OF CHARGING VALUE OF INVENTORY:

To charge units of inventory with an appropriate value the business will consistently use an
appropriate basis:

• FIFO (First In First Out)

• LIFO (Last In First Out)

• AVCO or WACO (Weighted Average Cost)

All will be illustrated using following information.

Illustration 1:

M Ltd had the following material transactions during the first week in March.

Details Date Quantity (units) Unit cost $

Opening balance 1st March 10 2.00

Receipts 2nd March 70 2.20

Issues 3rd March 40

Receipts 4th March 50 2.30

Issues 5th March 70

REQUIRED: calculate the value of closing stock using FIFO, LIFO and AVCO.

Question:

Explain why LIFO valuation method is not allowed.

NOTE: this is an Individual assignment and will be submitted in next session.

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LABOUR:

Refers to the cost of converting raw material into finished goods with supportive of overheads
cost during production process.

Direct and indirect labour:

One of the most important distinctions of labour is between direct and indirect costs.

• Direct labour costs make up part of the prime cost of a product and include the basic pay of
direct workers.

• Direct workers are those employees who are directly involved in producing the output of the
business.

• Indirect labour costs make up part of the overheads (indirect costs) and include the basic pay of
indirect workers.

• Indirect workers are those employees who are not directly involved in producing the output of
the business, (for example, maintenance staff, factory supervisors and canteen staff).

• Indirect labour costs also include the following:

– Bonus payments.

– Benefit contributions.

– Idle time (when workers are paid but are not making any products, for example when a
machine breaks down).

– Sick pay.

– Time spent by direct workers doing ‘indirect jobs’ for example, cleaning or repairing
machines.

METHODS/ SYSTEM OF CALCULATING LABOUR COST:

 Overtime and overtime premiums

If employees are entitled to extra pay when hours in excess of contracted hours are worked then
they will be paid for overtime. When employees work overtime, they receive an overtime

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payment which includes a basic pay element and an overtime premium. It is important that the
overtime payment is analysed correctly into direct and indirect labour costs.

• For example, if Fred is paid a basic wage of $8 per hour and overtime is paid at time and a half,
when Fred works overtime, he will receive an overtime payment of $12 per hour ($8 basic + $4
premium (50% × $8)).

Illustration 1 – Direct and indirect labour

Viera is a direct labour employee who works a standard 35 hours per week and is paid a basic
rate of $12 per hour. Overtime is paid at time and a third. In week 8 she worked 42 hours and
received a $50 bonus.

Complete the following table.

Direct labour cost Indirect labour cost

$ $
Basic pay for standard hours
$ $
Basic pay for overtime hours
$ $
Overtime premium
$ $
Bonus

 Incentive schemes
Incentive schemes can be aimed at individuals and/or groups.
• Many different systems exist in practice for calculating bonus schemes.
General rules are as follows:
– They should be closely related to the effort expended by employees.
– They should be agreed by employers/employees before being implemented.
– They should be easy to understand and simple to operate.
– They must be beneficial to all of those employees taking part in the scheme.
• Most bonus schemes pay a basic time rate, plus a portion of the time saved as compared to
some agreed allowed time.
These bonus schemes are known as premium bonus plans. Examples of such schemes are Halsey
and Rowan.

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• Halsey – the employee receives 50% of the time saved.
Time allowed – Time taken
Bonus = ––––––––––––––––––––– × Time rate
2

• Rowan – the proportion paid to the employee is based on the ratio of time taken to time
allowed.
Time taken
Bonus = ––––––––––– × Time rate × Time saved
Time allowed

Illustration 2 – Incentive schemes:

The following data relate to Job A.

Employee’s basic rate = $4.80 per hour

Allowed time for Job A = 1 hour

Time taken for Job A = 36 minutes

The employee is paid the basic rate for the allowed time for the job and then the bonus based on
any time saved.

REQUIRED: Calculate the following;

Halsey scheme – Total payment for Job A

Rowan scheme – Total payment for Job A

Test your understanding:

A company operates a factory which employed 40 direct workers throughout the four-week
period just ended. Direct employees were paid at a basic rate of $4.00 per hour for a 38-hour
week. Total hours of the direct workers in the four-week period were 6,528. Overtime, which is
paid at a premium of 35%, is worked in order to meet general production requirements.
Employee deductions total 30% of gross wages. 188 hours of direct workers’ time were
registered as idle.

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Calculate the following for the four-week period just ended.

i. Gross wages (earnings)

ii. Deductions
iii. Net wages
iv. Direct labour cost
v. Indirect labour cost

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