Employees are crucial assets of an organization. Undoubtedly, the world is rushing towards artificial intelligence, but it can never replace humans. The reason is the logical analysis of situations. But when you read the word labor/employee cost, what comes to mind first? Payments to employees. Basically salary and incentives. But does an employee only cost this much? Think again.
Employee cost starts well before the employee is hired. Determining the vacancy, the qualifications required for such vacancy, inviting applications, interviews, recruitment, training, etc., are the costs of an employee that a company incurs before the employee actually works for it. And, of course, the basic pay, bonus, incentives and other payments that are paid to an employee after hiring.
Types of Labor
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Labors are generally those classes of employee groups engaged in producing goods in a factory. Basically, labor is divided into three classes.
- Skilled labor
- Semi-skilled labor
- Unskilled labor
Skilled Labor
Working-class with the highest qualification of all, and they are also the highest-paid workers.
Semi-skilled Labor
These people do not have as much skills as skilled labor but more than unskilled labor.
Unskilled Labor
These people are assigned work that does not require much skills. They are given work that is repetitive in nature.
Types of Labor/Employee Cost
The two terms – employee and labor are similar yet different from each other. Hence, the costs related to both are also quite different. Employee cost is a broader concept and includes a number of costs. The various types of costs associated with employees include recruiting cost, HR, salary, wages, payroll taxes, benefits, incentives, paid leaves, training & development cost, consumables, office space, insurance, vacancy, retirement benefits, and much more. Whereas, labor cost includes wages paid, allowances, the bonus, idle time, labor turnovers, etc. Not only this, but labor cost also includes training costs (to be provided to skilled labor).
These labor costs are broadly divided into two parts:
Direct costs & indirect costs. These costs are differentiated on the basis of their allocation (i.e., direct or indirect) to a cost object.
Direct Labor Cost
Workers directly engaged in the production of goods are referred to as direct labor. One can easily identify them and assign them to the cost object. Such costs are directly in proportion with the volume of production.
For example, it takes 4 hours to produce a single unit and wages hour is $3. Therefore, the direct labor cost per unit is $7 (i.e., 4 hours * $3).
Indirect Labor Cost
Indirect labor is not directly engaged in the production of goods. They help direct labor in facilitating the production of goods. Hence, the cost of indirect labor cannot be assigned to the units manufactured. These are generally the same for any level of production.
For instance, the person appointed to look after the inventory (warehouse-keeper) will receive a fixed amount of pay whether the stock is of 1,000 units or 10,000 units.
Need for Computing Labor/Employee Cost
The requirement for calculating labor/employee cost arises due to the following reasons:
- To calculate the total cost of product and deciding the profit margin for selling price.
- For preparing labor budget.
- For analyzing productivity, efficiency and overall performance of the labor.
- To identify idle time and over time.
- For reducing labor turnovers.
There are various other reasons which require the calculation of the labor/employee cost.
Methods of Wage Payment
A Company has some guidelines for making payments to the labor in order to maintain their productivity. A worker producing more than the specified limit will receive a bonus along with minimum wages while the one who does not meet the limits will be paid minimum wages only.
The various methods followed by companies are:
Time Rate Method
Under this method, payment is made on the basis of time taken by the worker without considering the number of units produced.
Formula: Rate per hour * Number of hours worked
Piece Rate Method
Here, the payment of wages is made on the basis of number of units manufactured. It is also known as the straight piece rate method.
Formula: Rate per unit * Number of units manufactured
A company pays a bonus to its employees for producing above standard quantity. There are three main differential piece-rate systems for the calculation of bonus. These are:
Taylor’s Differential Piece Rate System
This method simply states the pay 80% to the workers who are inefficient or do not produce as per standard production quantity. And, 120% to those who are efficient enough to produce equal to or more than the standard production quantity.
Merrick’s Method of Piece Rate
This is quite similar to Taylor’s method but the only difference is that this method is comparatively lenient. Here, the workers receive wages as per straight piece rate for producing up to 83% of standard production quantity, 110% for 83% to 100% and 120% for anything above 100%.
Gantt Task Bonus Plan
Under this, workers receive guaranteed time rate wages even for below standard quantity production. They get a 20% bonus for producing the standard quantity and are paid at a high piece rate for the entire quantities produced by them in case of above-standard production.
Bonus System
A company pays a bonus to its worker not only for producing extra units but also for producing the standard quantity before time. Under differential piece rate system, the bonus is calculated on the basis of extra production while here, the base is time saved in producing standard quantity.
Halsey Premium Plan
Here, in addition to basic pay for the hours worked, workers are paid 50% of the wages for time saved.
Formula: (Hours Worked * Rate per Hour) + {(Standard Time – Hours Worked) * Rate per Hour * 50%}
Halsey-Weir Plan
The only difference between Halsey Premium Plan and Halsey-Weir Plan is that, here, the bonus is 33.33% instead of 50%.
Formula: (Hours Worked * Rate per Hour) + {(Standard Time – Hours Worked) * Rate per Hour * 33.33%}
Rowan Plan
The calculation of the bonus under this method is based on the proportion of time saved.
Formula: (Hours Worked * Rate per Hour) + [{(Standard Time – Hours Worked)/Standard Time} * Rate per Hour * Hours Worked]
Barth Variable Sharing Plan
The formula for calculating the bonus under this plan is as follows:
Formula: Square Root (Standard Time * Hours Worked) * Rate per Hour
Labor Turnovers
It refers to the change in the labor force of a company during a particular period. Labor turnover may be a result of personal reasons of employees or avoidable as well as unavoidable circumstances.
Calculation of Labor Turnovers
The various methods used in calculating labor turnover are:
Addition Method
It calculates labor turnover on the basis of new employees added during the period.
Formula: (Number of new employees added / Average number of employees during the period)*100
Separation Method
Here, the number of employees left the company is considered for the purpose of calculation.
Formula: (Number of employees left / Average number of employees during the period)*100
Replacement Method
It considers the number of replacements that took place in the company.
Formula: (Number of replacements / Average number of employees during the period)*100
Flux Method
It calculates labor turnover by combining the separation method either with the addition method or the replacement method.
Formula:
- [{(Number of new employee added + Number of employee left)/2} / Average number of employees during the period]*100
- [{(Number of replacements + Number of employee left)/2} / Average number of employees during the period]*100
Conclusion
The labor/employee cost is a very crucial element of cost. Its proper calculation is a must to arrive at the total cost of a product. This total cost eventually helps in determining the selling price and profit margin. There is a very thin line of difference between labor/employee cost which is important to understand in order to arrive at actual labor cost.