ACCA F2 Management Accounting - 2010 - Study text

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Chapter 5: Accounting for materials and labour

6.3 Piecework systems

In piecework systems, employees are usually paid a certain amount for the number

of units of output produced:

Basic pay = Units produced × Rate paid per unit produced

Example

A worker in a textile company sews buttons on shirts. She is paid $0.20 for each shirt

that she completes. During one week, she completes 800 shirts.

Her pay for the week, and the labour cost of sewing buttons on the 800 shirts, is:

800 × $0.20 = $160.

Differential piecework systems

Differential piecework systems encourage employees to increase the number of

units they produce by paying higher rates per unit when more units are produced.

It is quite common for employees involved in piecework schemes to be paid a

guaranteed minimum wage so that their earnings do not suffer too much when

production levels are low because of circumstances outside of their control.

For example, as employee is paid the following rates of pay:

Production Rate of pay per unit

Units $

0 – 100 1.50

101 – 200 1.75

201 – 300 2.00

The company pays a guaranteed minimum ways of $300 per week. In a week, the

employee produces 220 units. How much are his earnings for the week?

Production Rate of pay

per unit

Earnings

Units $ $

0 – 100 1.50 150

101 – 200 1.75 175

201 – 300 2.00 40

365

Don’t forget that if the employee had earned less than $300, he still would have been

paid the guaranteed minimum wage of $300 per week.

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6.4 Incentive schemes

Employees might be offered an incentive or bonus payment for improving their

productivity, or for achieving certain production targets during a period. The

purpose of an incentive scheme for greater productivity should be to:

 increase total production output with the same number of employees, or

 achieve the same total output volume, but in fewer hours of work.

Some of the benefits of the productivity improvement are given to the employees, in

the form of a bonus. This should give them an incentive to achieve the productivity

improvement. Incentive schemes may be based on:

 an individual’s performance or

 the performance of a work group as a whole.

Individual incentive schemes and group incentive schemes are similar for the

purpose of cost accounting.

(If the cost of a bonus payment can be traced directly to a cost unit it should be

treated as a direct labour cost. If it is difficult to trace the cost of a bonus payment to

a specific cost unit, for example because it is paid at a much later date, it will be

recorded as an indirect labour cost.)

The employer (company) also benefits from the productivity improvements,

because the unit cost of production should be reduced. If the total reduction in costs

is greater than the additional amount paid to employees, the company will benefit.

Example

A manufacturing company produces 1,000 units of a product each week. This

requires 900 direct labour hours. Direct labour employees are paid $12 per hour.

The company introduces an incentive scheme, in which it will pay a bonus of 5% of

the basic rate per hour worked if productivity can be improved by 10%, and either:

 the employees can make 10% more units each week in 900 hours, or

 the employees can produce 1,000 units each week in 10% fewer hours.

Does this bonus scheme benefit the company? If so, by how much?

Answer

At the moment the weekly cost of direct labour is 900 hours × $12 = $10,800, and the

direct labour cost per unit is $10,800/1,000 = $10.80.

(a) If 10% more units are made each week in the same number of hours (900

hours), the labour cost will be (including the bonus of 5%):

- 900 hours × $12 × 1.05 = $11,340.

- The cost per unit will be $11,340/1,100 = $10.31.

- The cost per unit will fall by $0.49 or 4.5%.

Chapter 5: Accounting for materials and labour

(b) If 1,000 units are made each week in only 810 hours (90% x 900), the direct

labour cost will be (including the bonus of 5%):

- 810 hours × $12 × 1.05 = $10,206.

- The cost per unit will be $10,206/1,000 = $10.21.

- The cost per unit will fall by $0.59 or 5.5%.

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Labour efficiency and labour turnover

 Labour efficiency ratio (productivity ratio)

 Capacity utilisation ratio

 Production volume ratio

 Labour turnover rate

 Costs and causes of labour turnover

7 Labour efficiency and labour turnover

7.1 Labour efficiency ratio (productivity ratio)

Non-financial information might be provided to management about labour

performance. Performance measurements include the labour efficiency ratio or

productivity ratio:

Labour efficiency ratio =

Expected time to produce the output ( in hours )

Actual time to produce the output ( in hours )

×100%

When output is produced in exactly the time expected, the efficiency ratio is 100%.

When output is produced more quickly than expected, the efficiency ratio is above

100%.

Example

During July, a factory produced 3,600 units of a product. The expected production

time is 3 direct labour hours for each unit. The actual number of direct labour hours

worked in the month was 10,000 hours.

Efficiency ratio =

3,600 × 3 hours

()

10,000 hours

⎡

⎣

⎢

⎤

⎦

⎥

×100% = 108%

Efficiency ratio and idle time

When a labour efficiency ratio is calculated, the actual hours worked should exclude

any hours recorded as idle time.

7.2 Capacity utilisation ratio

Employees are not always engaged in active work during the time they attend the

work place. Employees might be ‘idle’ for several reasons, such as waiting for the

next work to come along, or because of a halt in production due to a machine

breakdown.

Chapter 5: Accounting for materials and labour

A capacity utilisation ratio is a ratio that measures the actual hours actively working

as a percentage of the actual hours that were available for working.

%100

for wor

availablehoursTotal

workingactivein spent Hours

= ration utilisatioCapacity ×

Example

A production department has 6 employees who each work 40 hours a week. In a

particular week, the recorded idle time was 25 hours.

Total hours available for work = 6 employees × 40 hours = 240 hours.

Capacity utilisation ratio = [(240 – 25)/240]

× 100% = 89.6%

7.3 Production volume ratio

Labour activity can also be measured by a production volume ratio which is

calculated as follows:

100%

for workavailablehoursTotal

output theproduce to timeExpected

ratio volumeProduction ×=

The production volume ratio can be calculated as follows:

Production volume ratio = Labour efficiency ratio × Capacity utilisation ratio

Example

During May there were 21 working days of 8 hours per day. The workforce consists

of 10 employees, who all do the same work.

Due to problems in the production system and a machine breakdown, 240 hours

were recorded as idle time during the month.

During May, the workforce produced 5,400 units of output. The expected time per

unit of output is 15 minutes (= 0.25 hours).

Required

Calculate, for May:

(a) the efficiency ratio

(b) the capacity utilisation ratio

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Answer

To calculate the efficiency ratio, the hours worked should exclude idle time. Hours

worked = (21 days × 8 hours × 10 employees) – 240 hours idle time = 1,680 – 240 =

1,440 hours.

(a)

Efficiency ratio

Expected time to produce 5,400 units = 5,400 × 0.25 hours = 1,350 hours.

Efficiency ratio = (1,350/1,440) × 100% = 93.75%

(b)

Capacity utilisation ratio

Active hours worked/Hours available

= (1,440 hours/1,680 hours) × 100% = 85.71%

(c)

Production volume ratio

Expected time to produce 5,400 units/Total hours available

= (1,350 hours/1,680 hours) × 100% = 80.35%.

Efficiency ratio × Capacity utilisation ratio = Production volume ratio

93.75% × 85.71% = 80.35%.

7.4 Labour turnover rate

Labour turnover occurs when employees leave their job and have to be replaced.

The labour turnover rate is a measure of the rate at which employees are leaving

and have to be replaced.

Number of employees leaving/being replaced each year

Average number of employee positions in the year

×100%

Example

A company employs 4,800 employees. During the past 12 months, 660 employees

left the company and had to be replaced.

Labour turnover rate =

100%×

660

4,800

⎛

⎝

⎜

⎞

⎠

⎟

=13.75%

Example

A company employed 2,800 people at the beginning of the year. During the year 420

people left and 450 were recruited. There were 2,830 employees at the end of the

year.

Average number of employees = (2,800 + 2,830)/2 = 2,815

Labour turnover rate = (420/2,815) × 100% = 14.9%.

Chapter 5: Accounting for materials and labour

Exercise 2

A company employed 600 employees at the beginning of the year and 630

employees at the end of the year. During the past 12 months, 35 employees left the

company and had to be replaced.

What was the labour turnover rate?

7.5 Costs and causes of labour turnover

The main cause of labour turnover is when employees leave one company to go and

work for another.

Labour turnover can be very costly for an employer, and result in higher costs.

 When employees leave, their experience is lost. New employees taking their

place are less experienced, and will be less efficient until they learn how to do

the job. A high labour turnover, by reducing efficiency, increases costs.

 New employees might make many more mistakes, and so there will be

additional costs of correcting faulty work.

 New employees might have to be trained, and there will be additional training

costs.

 A very high labour turnover rate could have an adverse effect on the morale and

efficiency of the employees who remain in their jobs.

Practice multiple choice questions

1 The demand for an item of material is 8,000 units each year. The cost of making an

order is $240. The purchase cost per unit is $9 and the holding cost of inventory is

6% per annum of the purchase cost. Using the economic order quantity formula,

what quantity of the item should be purchased in each order (to the nearest unit)?

A 800

B 843

C 1,886

D 2,667 (1 mark)

A manufacturing company uses the economic order quantity (EOQ) formula to

decide the purchase quantities for its main items of raw materials. Due to an

increase in interest rates, the cost of holding inventory has increased. What will be

the effect of this cost increase on the EOQ for each raw material item and on annual

ordering costs?

A The EOQ will be lower and annual ordering costs higher.

B The EOQ will be lower and annual ordering costs will not be affected.

C The EOQ will be higher and annual ordering costs lower.

D The EOQ will be higher and annual ordering costs higher. (2 marks)

3 A company uses the economic order quantity formula to decide the purchase

quantity for materials. The purchase cost of item 1234 is $25 per unit. Annual

Paper F2: Management Accounting

demand is 10,000 units. The annual holding cost is $2.50 per unit and ordering costs

are $500 per order. The supplier is offering a reduction is the purchase price to $23

per unit on all orders of 5,000 units or more.

Which one of the following statements is correct?

A The company will minimise its total annual costs if it continues to purchase in

the economic order quantity of 1,000 units per order.

B The company will minimise its total annual costs if it continues to purchase in

the economic order quantity of 2,000 units per order.

C The company will minimise its total annual costs if it takes the large order

discount and purchases in quantities of 5,000 units per order.

D The company will minimise its total annual costs if it takes the large order

discount and purchases in quantities of 10,000 units per order.

(2 marks)

A company manufactures Product Z in batches. Output capacity is 1,000 units of

Product Z per week but demand is only 200 units per week. There are 50 weeks in

each year. The annual cost of holding finished units o Product Z in store is $2 per

unit per year. Set-up costs for a batch of Product Z are $800 per batch.

What batch production quantity for Product Z will minimise total annual costs, to

the nearest 100 units?

A 400 units

B 2,800 units

C 3,200 units

D 7,100 units (2 marks)

5 A production department uses Component P to manufacture a product. This

component is purchased from an external supplier in quantities of 3,000 units per

order. Daily usage is 150 units of the component each day. The supply lead time is

normally 6 days, but might be as little as 4 days or as much as 10 days.

To avoid the risk of running out of inventory of Component P, what should be the

reorder level for this item?

A 3,900 units

B 1,500 units

C 900 units

D 600 units (2 marks)

6 A production department consists of 15 direct labour employees who each work 36

hours per week. Output from the department is expected to be 4 units of product

per direct labour hour worked. During a particular week, the department recorded

500 hours of time spent working on production and actual output was 2,100 units of

the product.

What was the production volume ratio for the department for the week?

A 92.5%

B 97.2%

Chapter 5: Accounting for materials and labour

C 102.9%

D 105.0% (2 marks)

7 A company employed 5,700 employees at the end of a financial year. During the

year 600 employees left the company and 360 were recruited.

What was the rate of labour turnover in the year?

A 10.3%

B 10.5%

C 10.8%

D 16.5% (2 marks)

Paper F2: Management Accounting

ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing

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