Learning Outcomes
After reading this article, you will understand how labour costs are classified and recorded in organisations. You will be able to explain the difference between time-based, piecework, and incentive pay methods, and identify how each affects cost allocation and employee motivation. You will know how to calculate gross wages under different payment schemes, describe the process of labour cost recording, and understand the impact of various incentive schemes on performance and labour cost control.
ACCA Management Accounting (MA) Syllabus
For ACCA Management Accounting (MA), you are required to understand how labour costs are recorded and calculated under different pay systems, the use of incentive schemes, and the relevance of each system for management decisions and control. Focus your revision on the following key areas:
- The classification and calculation of direct and indirect labour costs
- Time-based wage systems and their features
- Piecework systems, including straight and differential rates
- Individual and group incentive schemes and their calculation
- The recording and analysis of labour costs in the accounts
- The use of labour cost data for planning, control, and performance measurement
- Payroll records and the allocation of employee pay to cost centres
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the main difference between time-based pay and piecework pay systems?
- In which circumstances might an organisation prefer to use an individual incentive scheme rather than a group scheme?
- Which part of an overtime payment is usually classified as an indirect labour cost?
- Under a piecework scheme with a guaranteed minimum wage, how is an employee’s pay calculated if output is lower than expected?
Introduction
Labour costs are a significant element of total production costs in many businesses. Accurate calculation, classification, and recording of these costs are essential for planning, control, and performance measurement. Different methods of employee remuneration influence both cost structures and employee motivation. Understanding these systems helps management accountants allocate labour costs, design appropriate bonus schemes, and ensure that the payroll is recorded properly in the accounting records.
Labour Cost Classification
Labour costs are split into direct and indirect components. Correct classification supports management in controlling costs, measuring performance, and pricing products.
Key Term: Direct labour
Wages paid to workers directly involved in the manufacture or provision of a specific product or service, which can be traced to a cost unit.Key Term: Indirect labour
Wages paid to employees who do not work directly on a product or service (e.g., supervisors, maintenance staff), forming part of business overheads.
Time-Based Pay Systems
A time-based wage system pays employees according to the number of hours attended or worked, regardless of output.
- Wages = (Hours worked × Basic hourly rate) + Overtime premiums (if any)
- Commonly used where output is hard to measure or quality is critical.
- Does not directly encourage increased productivity.
Key Term: Time-based pay
Payment based on the time an employee works, at an agreed rate per hour, day, week, or month, regardless of output produced.
Overtime Pay
When employees are required to work beyond contracted hours, overtime is paid at a higher rate (e.g., time and a half). Overtime comprises a basic pay element and an overtime premium.
- Basic rate element is classified as direct labour for production workers.
- The overtime premium (the extra above basic pay) is usually classified as indirect labour unless overtime is specifically incurred at the customer's request.
Piecework Systems
Under piecework, employees are paid a fixed amount for each unit they produce.
- Wages = Number of units produced × Rate per unit
- Encourages higher output and efficiency.
- Suitable when output is easily measurable and quality standards can be maintained.
Key Term: Piecework
A pay system where employees are paid a specified rate for each unit produced, rather than for time worked.
Types of Piecework Schemes
- Straight piecework: A single rate per unit regardless of number produced.
- Differential piecework: Higher rates per unit after reaching specified production thresholds.
Key Term: Differential piecework
A piecework system where higher output levels attract higher rates per unit, thereby rewarding increased productivity.
Guaranteed Minimum Wage
Many piecework schemes include a guaranteed minimum weekly wage to comply with minimum wage laws and protect employees from very low earnings during periods of low output.
Incentive Schemes
In incentive schemes are designed to reward employees for increased efficiency or productivity. These can operate at an individual or group level and often supplement basic pay.
Key Term: Incentive scheme
A pay arrangement offering financial rewards for achieving productivity or efficiency targets, above the basic wage.Key Term: Bonus
An extra payment made to an employee or group for exceeding specified performance targets or time savings.
Types of Incentive Schemes
- Individual bonus schemes: Reward each worker based on their personal performance.
- Group bonus schemes: Reward a team or group based on collective output or savings.
Methods of Calculating Bonuses
Several methods exist to share the gain from time saved or output above standard. One common approach is to allow the employee to keep a fixed proportion of the time (or cost) saved, paid at the basic rate.
Worked Example 1.1
An employee works a standard 8-hour day. The basic rate is £15 per hour. For each unit, the standard time allowed is 6 minutes. The worker produces 90 units in 8 hours. The piece rate is £1.80 per unit. What is the employee's gross pay for the day if a minimum wage guarantee is 80% of basic pay?
- Step 1: Calculate standard output for 8 hours
8 hours × 60 minutes = 480 minutes
Standard output: 480 / 6 = 80 units - Step 2: Units produced = 90 (more than standard)
Gross pay by piecework = 90 × £1.80 = £162 - Step 3: Minimum guarantee pay = 8 × £15 × 80% = £96
- Step 4: Final wage = higher of piecework pay or guaranteed minimum = £162
Answer:
The employee receives £162 for the day.
Worked Example 1.2
A team must assemble 400 products in a week. The standard is 40 products per hour; weekly hours worked by the group are 45. The basic hourly rate is £10. The group receives a bonus of 60% of the time saved at the basic rate, shared equally. What is the gross bonus per team member if there are 5 members?
Actual time taken: 45 hours
Standard time allowed: 400 / 40 = 10 hours
Time saved: 45 - 10 = 35 hours (but standard cannot exceed actual, so time saved is 0; recalculate: 400 units @ 1.5 mins per unit = 600 mins = 10 hours; group actually worked 45 hours).
This doesn't make sense unless the group worked fewer hours—adjust question for a valid bonus situation:
Suppose:
Standard time allowed: 400 / 40 = 10 hours
Actual time worked: 8 hours (team more efficient)
Time saved: 10 - 8 = 2 hours
Bonus = 2 × £10 × 60% = £12
Each member gets £12 / 5 = £2.40
Answer:
Each group member earns a £2.40 bonus.
Payroll Recording and Labour Cost Allocation
Labour costs are processed by the payroll department, which calculates gross pay based on hours worked or output, subtracts statutory deductions, and analyses costs for allocation to cost centres.
- Direct labour is allocated to jobs or products.
- Indirect labour (such as supervisor pay, general overtime premium, bonuses unrelated to specific jobs) is charged to overheads.
Recording Labour Costs in Accounts
Labour costs must be recorded in the accounts using journal entries.
- Direct labour is debited to Work-in-Progress (WIP)
- Indirect labour is debited to Production Overheads
- Total wages are credited from Bank or Cash (for payment), with analysis by direct and indirect categories.
Controlling Labour Costs
Management accounting systems use time and activity records (such as timesheets and job cards) to track labour input. This supports both cost control and performance measurement.
Effective incentive schemes and wage systems support motivation and help align individual performance with organisational targets.
Exam Warning
Calculating bonuses under different incentive schemes requires careful attention to the method stated in the scenario. The allocation between direct and indirect labour costs is also a common ACCA test area.
Revision Tip
Learn the formulas for gross wages under time-based, piecework, and bonus schemes. Practise allocating labour costs to direct or overhead categories.
Summary
Time-based, piecework, and incentive schemes are essential methods of paying for labour. Each has different impacts on cost control and worker motivation. Time-based pay is straightforward but may not incentivise higher output. Piecework and differential piecework link pay to productivity, which can improve efficiency but may affect quality if not managed carefully. Incentive schemes further encourage improved performance, either individually or as a group. Accurate recording and allocation of all labour costs is fundamental for effective cost control and management decision-making.
Key Point Checklist
This article has covered the following key knowledge points:
- Distinguish between direct and indirect labour costs
- Explain time-based, piecework, and differential piecework systems
- Calculate wages under different pay systems, including overtime and minimum guarantees
- Describe individual and group incentive schemes and their calculations
- Record and allocate labour costs in accounts appropriately
- Recognise how incentive pay affects motivation and cost control
Key Terms and Concepts
- Direct labour
- Indirect labour
- Time-based pay
- Piecework
- Differential piecework
- Incentive scheme
- Bonus