Cost Accounting

An Introduction

Introduction

• Cost is a measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services.

• Cost is the amount of actual or notional expenditure relating to a product, job, service, process or activity.

• Cost is often used as a generic term to describe various types of costs.

• Costing is the technique and process of ascertaining costs.

Introduction

• Cost Accounting is the process of accounting from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. It includes:– Collecting, classifying, recording, allocating and analyzing costs

– Preparation of periodical statements and reports for ascertaining and controlling costs

– Application of cost control methods

– Ascertainment of profitability of activities carried out or planned.

• Cost Accounting is the processing and evaluation of monetary and non-monetary data to provide information for internal planning, control of business operations, managerial decisions and special analysis.

Introduction

• Cost Accountancy is the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived there from for the purpose of managerial decision making.

• Objectives of Cost Accounting– To ascertain cost

– To control cost

– To provide information for decision making

– To determine selling price

– To ascertain costing profit

Advantages of Cost Accounting

• Helps in ascertainment of cost• Helps in control of cost• Helps in decision making (make or buy, retain or replace, continue

or shut down, accept or reject orders, etc)• Helps in fixing selling prices• Helps in inventory control• Helps in cost reduction• Helps in measurement of efficiency• Helps in preparation of budgets• Helps in identifying unprofitable activities• Helps in identifying material losses• Helps in identifying idle time, idle capacity• Helps in improving productivity• Helps in cost comparison

Essentials of a Good System

• Suitability – to the nature of business• Tailor made system – to meet requirements of the business• Simplicity – easy to understand and simple to operate• Economical – to install and operate• Flexibility – to adapt to the changing business needs• Accuracy – must provide accurate information• Promptness – of information• Support of staff – must have staff co-operation and participation• Cost control – must ensure cost control in various fields• Clearly defined Cost Centers – least ambiguity• Detail – give relevant details but avoid unnecessary detail

Cost Concepts

• Cost Unit – Is a unit of product, service or time in terms of which costs are ascertained or expressed. It is a unit of measurement.

• Responsibility Centers – is the unit or function of an organization under the control of a manager who has direct responsibility for its performance. E.g. Cost Center, Revenue Center, Profit Center, Contribution Center, Investment Center.

• Cost Center – Is a location, person or item of equipment for which costs may be ascertained and used for the purposes of cost control.

• Types of Cost Centers:– Personal Cost Center – person or group of persons– Impersonal Cost Center – location or equipment– Production Cost Center – where actual production takes place– Service Cost Center – departments which render service to other cost

centers• Cost Object – any product, service, process or activity for which a

separate measurement of cost is required.

Financial & Cost Accounting

No. Basis Financial Accounting Cost Accounting

1. Objective Financial performance and position

Ascertain cost and cost control

2. Costs and profits Shows overall costs and profit / loss

Shows details for each product, process, job, contract, etc

3. Control / Report Emphasis on reporting Emphasis on control and reporting

4. Decision making Limited use Designed for decision making

5. Responsibility Does not fix responsibility Can effectively fix responsibility

6. Time frame Focus on historical data Focus on present and future

7. Type of reports General reports like P&L Account, Balance Sheet, Cash Flow Statement

Can generate special reports and analysis

8. Legal need Statutory requirement Voluntary, except for some cases

9. Transactions Records external transactions Records internal and external transactions

10. Reader Everybody Internal management

11. Formats Standard, as per law Tailor made

12. Access Everybody, except for some Very limited access

13. Unit of value Monetary Monetary and physical

Methods of Costing

No. Costing Method Meaning Application

1. Job Costing A job, product, batch, contract, service or any specific order is treated as a cost unit.

Engineering, Construction, Ship Building, Pharmaceuticals, etc

Contract Costing For specific orders, contract or service.

Construction, Engineering, etc

Batch Costing Production is done in batches. Garments, Pharmaceuticals, Components, Toys, Tyres, Tubes, etc

2. Process Costing Products subject to a process; output of one process becomes input for the next process.

Paper, Chemicals, Textiles, Sugar, etc

Operation Costing

Type of operations performed is monitored.

Engineering, Textiles, etc

Unit Costing

Single product, process involved or where product is uniform, continuous and identical.

Cement, Steel, etc

Service Costing For service operations Transport, Railways, Hotels, Hospitals, etc.

Multiple or Composite Costing

Application of two or more costing methods. Involves manufacturing and assembly operations.

Vehicles, Consumer Goods, etc

Costing Techniques

No. Costing Technique Description

1. Marginal Costing Charging variable costs to operations, processes or products and writing off all fixed costs against profits in the period in which they arise.

2. Direct Costing Charging all direct costs to operations, processes or products and writing off all indirect costs against profits in the period in which they arise.

3. Absorption Costing

Charging all variable costs and fixed production overheads to operations, processes or products and writing off selling, distribution and administration overheads against profits in the period in which they arise.

4. Uniform Costing

Using the same costing principles and / or practices by a number of firms in the same industry. Helps in inter-firm comparison, price fixation, cost control / reduction and seeking government tax relief / protection.

5. Standard Costing System which involves fixation of cost standards, ascertain variances of actual cost with standard cost, variance analysis and presentation for corrective action and decision making.

6. Budgetary Control System which involves establishment of budgets, comparison of actual with budget, variance analysis and corrective action.

7. Historical Costing Actual cost ascertained after it has been incurred.

Cost Treatment

• Cost Ascertainment is the process of determining actual costs after they have been incurred.

• Cost Estimation is the process of determining future costs in advance before production starts, on the basis of actual past cost adjusted for anticipated future changes.

• Cost Allocation is the process of charging the full amount of an individual item or cost directly to the cost center for which the item of cost was incurred.

• Cost Apportionment is the process of charging the proportion of common items of cost to two or more cost centers on some equitable basis.

• Cost Absorption is charging cost from cost centers to products or services by means of a pre-determined absorption rate.

Cost ClassificationClassification Meaning Example

By Nature or Element

Direct Material Cost Which can be directly allocated to a product, job or process

Basic raw material, primary packing material

Indirect Material Cost Which cannot be directly allocated to a product, job or process

Stores, consumables, some low value items

Direct Labour Cost Labour directly engaged for a specific job, contract or work order.

Shop floor labour

Indirect Labour Cost Labour not directly engaged for a specific job, contract or work order.

Staff departments

Direct Expenses All direct costs other than materials and labour costs.

Processing charges, machine hire charges, excise duty, etc

Indirect Expenses All indirect costs other than indirect materials and indirect labour costs.

Rent, repairs, telephones, electricity, utility costs, insurance, depreciation

Factory Overheads Sum of indirect material, indirect labour and indirect expenses for the factory.

Administration Overheads

Sum of indirect material, indirect labour and indirect expenses for the office.

Selling Overheads Sum of indirect material, indirect labour and indirect expenses for selling.

Distribution Overheads

Sum of indirect material, indirect labour and indirect expenses for distribution.

Cost Classification

By Function

Production Cost Sum of direct material, direct labour, direct expenses and factory overheads.

Administrative Cost Cost of the Admin Department for the management of the organization.

Selling Cost Cost for seeking to create and stimulate demand and secure orders.

Distribution Cost Costs for making the packed product ready for dispatch to recovery of material for recycling, if any.

Research Cost Costs for developing new or improved product / application.

Pre-Production Cost Cost of trial run or production.

By Relation to Cost Center

Direct Cost Sum of direct material, direct labour and direct expenses of the Cost Center.

Indirect Cost Sum of indirect material, indirect labour and indirect expenses of the Cost Center. Also called as Overhead Cost.

This cost is apportioned to the Cost Center.

Classification Meaning Example

Cost Classification

By Variability / Behaviour

Fixed Cost Costs that do not vary with the volume of production.

Rent, insurance, salary

Variable Cost Costs that vary directly with the volume of production.

All direct costs, variable overheads

Semi-Variable / Semi-Fixed Cost

Costs where one part remains fixed in a given range and the other part varies with volume of production.

Telephones, electricity

By Controllability

Controllable Cost Costs that can be influenced by a decision maker at a particular level.

Direct costs

Uncontrollable Cost Costs that cannot be influenced by a decision maker at that particular level.

All costs can ultimately be controlled at the top.

By Normality

Normal Cost Cost that is normally incurred at a level of operation.

Cost as per standard

Abnormal Cost Cost that is not normal at the level of operation.

Abnormal loss, abnormal idle time

Classification Meaning Example

Cost Classification

By Inventory

Product Cost Cost that is absorbed to value of stock Manufacturing costs

Period Cost Cost that are expensed out. Fixed costs

Expired Cost Costs incurred for generating revenue. Expensed cost.

COGS, admin expenses

Deferred Cost Unexpired cost, capitalized cost, deferred revenue expenditure – would provide benefits in future periods.

Fixed assets, prepaid expenses, R&D expenses

By Time

Historical Cost Actual cost ascertained after it has been incurred.

Pre-determined Cost Future cost ascertained in advance – could be standard or estimated cost

Standard Cost What the cost should be - based on engineering specifications and efficient operating conditions

Standard material and labour costs

Estimated Cost What the cost will be - estimated on the basis of past experience adjusted for anticipated changes.

Projection for actual material cost for next year

Classification Meaning Example

Cost ClassificationBy Decision Making

Relevant Costs Cost that is relevant for making the underlying decision.

Irrelevant Costs Cost that is not relevant for making the underlying decision.

Sunk Costs Historical or past cost already incurred and cannot be changed.

Shut-Down Costs Fixed costs to be incurred even when the plant is shut down.

Out of Pocket Costs Costs that involve cash outlay.

Opportunity Costs The value of sacrifice made in accepting an alternate course of action.

Imputed Costs Notional costs that do not have a cash outlay, are similar to opportunity cost.

Rent of own premises, interest on own capital

Differential Costs Increase or decrease in cost due to change in activity level. Also called incremental cost.

Marginal Cost Total variable cost attributable to one unit of product. Incremental cost of making one unit of product.

Replacement Cost Current cost of an identical asset.

Conversion Cost Cost of converting raw material into a finished product.

Committed Costs Costs that are committed and have to be incurred.

Discretionary Costs Costs that can be avoided.

Classification Meaning Example

Cost Audit

• Cost Audit is the verification of cost accounts and a check on the adherence to the Cost Accounting plan. It comprises of verification of the cost records and ensuring that they adhere to the principles of cost accounting.

• Purpose of Cost Audit are protective (examine undue wastage / losses to reflect realistic cost of production) and constructive (provide information for management decision making).

• Items excluded from Cost Accounts – items of financial nature like Other Income, Finance Costs, Financial Accounting adjustments and appropriations. These include profit on sale of fixed assets / investments, interest income / expense, dividend / rent income, preliminary expenses written off, tax, cash discount, provision for doubtful debts, etc.

Cost Components

No. Cost Component Description

1. Prime Cost Direct Material Cost + Direct Labour Cost + Direct Expenses

(Direct Material Cost = Opg. Stock of RM + Net Purchase Cost – Clg. Stock of RM)

2. Works or Factory Cost

Prime Cost + Factory Overheads + Opg. Stock of WIP – Clg. Stock of WIP

3. Cost of Production or Cost of Goods Produced

Factory Cost + Admin Overheads

4. Cost of Goods Sold Cost of Production + Opg. Stock of FG – Clg. Stock of FG

5. Cost of Sales Cost of Goods Sold + Selling & Distribution Overheads

Costing P&L AccountNo. Particulars Amount Per Unit

A

Direct Material Cost = Opening Stock of Materials+ Purchases+ Expenses on Purchases- Purchase Returns - Closing Stock of Materials - Value of Normal Scrap of Direct Materials

(on number of units produced)

B

Direct Labour Cost = Direct Labour Cost Paid + Outstanding / Payable- Prepaid

(on number of units produced)

C Direct Expenses (on number of units produced)

D Prime Cost = (A + B + C) (on number of units produced)

E

Works / Factory Overheads= Factory Overheads Paid- Value of Normal Scrap of Indirect Materials+ Opening Stock of WIP- Closing Stock of WIP

(on number of units produced)

F Works or Factory Cost = (D + E) (on number of units produced)

Costing P&L Account

No. Particulars Amount Per Unit

G Office and Admin Expenses (on number of units produced)

H Cost of Goods Produced = (F + G) (on number of units produced)

IFG Stock Adjustment+ Opening Stock of FG- Closing Stock of FG

J Cost of Goods Sold = (H + I) (on number of units sold)

K Selling & Distribution Expenses (on number of units sold)

L Cost of Sales = (J + K) (on number of units sold)

M Profit (on number of units sold)

N Sales = (L + M) (on number of units sold)

Material Cost

Fundamentals

Material Cost

• Material Cost can be Direct and Indirect

• Direct Materials are those which can be identified with and directly allocated to the product, job or process.

• Includes basic material and primary packing material

• Indirect Materials are those which cannot be easily identified with and directly allocated to the product, job or process.

• Includes stores, consumables, small value materials

Direct Material Cost

• The total direct material cost includes:– Purchase price

– Customs Duty, Excise Duty, VAT, CST, Octroi

– Inward freight

– Insurance

– Directly attributable expenses like packing expenses, inspection, storage, delivery, etc

– (Less) Volume or Trade Discounts

– Rebates, Duty Drawback, MODVAT, Subsidies, etc

– (Less) Cost of containers recovered on return

Objectives of Material Control

• Avoid under stocking or shortages

• Avoid over stocking and obsolescence

• Ensure proper quality from reliable sources

• Explore alternate sources and reduce cost

• Reduce total cost of materials, including ordering and carrying costs

• Avoid wastages and losses in storage and use

• Maintain proper inventory records

• Provide information for decision making

Requirements for Material Control

• Proper co-ordination• Proper purchase system• Proper storage system• Proper issue system• Perpetual inventory system• Continuous stock taking system• Budgetary control system• Proper documentation• Proper accounting system• Proper reporting system

Documents for Materials

• Purchase of Materials– Bill of Materials (BoM)– Purchase Requisition– Supplier Selection – Purchase Order– Goods Received Note – Inspection Note– Return of Rejected Material– Bill Passing– Making Payment to Supplier

• Issue of Materials– Bin Card– Stores Ledger– Material Requisition– Material Return Note– Material Transfer Note

Material Losses

• Waste – portion of raw material lost during processing or storage, having no recovery value

• Arises due to shrinkage, evaporation, chemical reaction, etc• Scrap – incidental residue manufacturing operations usually of small

amount and low value recoverable without further processing• Arises due to processing of material, defective or broken parts and

obsolescence / abortion of development projects• Defective Work – work that has some imperfections which can be rectified

by additional material or processing• Arises due to improper product design, bad raw material, poor

workmanship, inadequate supervision, improper material handling, defective machinery or improper training

• Spoiled Work – work that cannot be reconditioned or brought to standard and must be sold as scrap or “seconds”

• Arises due to improper product design, improper machinery or process used, improper material quality or untrained operators

• Normal Loss is charged to the particular job or as production overheads• Abnormal Loss is charged to Costing Profit & Loss Account

Controlling Material Loss

• Proper product design

• Proper selection of manufacturing process

• Proper selection of machinery & equipment

• Proper process control

• Proper storage and material handling

• Trained manpower

• Proper record keeping

• Proper control system having scientific standards

• Proper reporting system

• Defined accountability

• Corrective action

Materials Issue Pricing

• Cost Price Methods– FIFO (First In First Out)– LIFO (Last In First Out)– HIFO (Highest In First Out)– Base Stock Price

• Average Price Methods– Simple Average– Weighted Average– Periodic Simple / Weighted Average– Moving Simple / Weighted Average

• Notional Price Methods– Standard Price– Inflated Price– Replacement or Market Price

• Weighted Average and FIFO Methods are used in Accounting

Inventory Control

• Inventory is tangible property or assets held – for sale in the ordinary course of business or – in the process of production for sale or– for consumption in the production of goods or services for sale including

maintenance supplies and consumables other than machinery spares• Inventory comprises of raw materials, stores & spares, work-in-process and

finished goods • Inventory control includes planning, organizing and controlling purchase and

storage to ensure availability in terms of quantity, quality, timeliness at least cost

• Monitoring level of inventory with respect to production and sales• Releasing material in a systematic manner to ensure quality at least cost

and reduce wastage / obsolescence• Analyze inventory levels and suggest optimal and alternate uses of material

including value engineering• Ensure physical stock taking to avoid pilferage• Provide information for inventory valuation

Techniques of Inventory Control

• ABC Analysis

• Economic Order Quantity (EOQ)

• Stock Levels – minimum, maximum, reorder level, reorder quantity

• Inventory Turnover Ratio

• Slow and Non-Moving Items

• Purchase, Storage and Issue Procedure

• Two Bin System

• Perpetual Inventory Records and Continuous Stock Verification

• Budgetary System

ABC Analysis

• A: 70% value, 10% items

• B: 20% value, 20% items

• C: 10% value, 70% items

• Ensures control on high value items

• Saves time and cost of monitoring

• Reduces total investment in inventory

• Facilitates faster decision making

• Better utilization of resources

• Better physical control of stock

Economic Order Quantity (EOQ)

• Level at which the ordering and carrying costs are minimum. At EOQ, the ordering and carrying costs are equal.

• Ordering Cost includes costs for placing an order, transportation, receiving goods and inspecting goods

• Ordering Cost reduces with order size

• Carrying Cost includes costs for storage space, handling materials, insurance, obsolescence and personnel.

• Carrying Cost increases with order size

• Dependent on periodicity and annual material consumption

• EOQ determines quantity to be ordered at a given time

EOQ Technique

• Assumes prior knowledge of annual usage, constant usage rate, constant ordering cost, constant carrying cost and zero lead / delivery time

• EOQ can be determined by graphical, tabular or formula method• Find the level at which total of ordering and carrying cost is least or

ordering cost equals carrying cost• EOQ = √(2AO / C) where A = Annual Consumption, O = Ordering

Cost per order and C = Carrying Cost per order• EOQ = √(2AO/IP) where I = Inventory or Stock Holding Cost (as %

of average stock value) and P = Price per unit• Economic Order Frequency (in days) = 365 / (Number of orders per

year)• Total annual ordering and carrying cost at EOQ = √(2AOC)

Stock Levels

• Maximum Stock Level is the maximum stock level that can be held in store.

• It avoids cost of over-stocking such as costs for storage, investment, insurance and risk of obsolescence

• Dependent on reorder level, reorder quantity, rate of consumption, reorder period, availability of funds and storage space, cost of storage, insurance, obsolescence, price fluctuation, etc

• Formula: Maximum Level = Reorder Level + Reorder Quantity – (Minimum Consumption x Minimum Reorder Period)

Stock Levels

• Minimum Stock Level is the level below which the stock should not be allowed to fall

• Dependent on reorder level, rate of consumption and reorder period

• Formula: Minimum Level = Reorder Level – (Normal Consumption x Reorder Period)

• Reorder Level is the level of stock at which fresh replenishment order should be placed

• Dependent on consumption rate, reorder period and minimum level

• Formula: Reorder Level = Maximum Consumption x Maximum Reorder Period OR Minimum Level + (Normal Consumption x Reorder Period)

Stock Levels

• Average Stock Level = Minimum Level + ½ Reorder Quantity OR (Minimum Level + Maximum Level) / 2

• Danger Level is the level at which only emergency material issue is done (normal material issue is stopped)

• It is a level at which urgent ordering action is required

• If Danger Level is below Minimum Level, urgent corrective action is required

• If Danger Level is above Minimum Level, it calls for preventive action

• Dependent on rate of consumption and reorder period

• Formula: Normal Consumption Rate x Maximum Reorder Period for emergency purchases

Inventory Turnover Ratio

• Indicates the speed with which inventory is consumed• A high ratio indicates fast moving stock, low ratio

indicates slow moving stock• Inventory Turnover Ratio = Materials Consumed /

Average Stock Held expressed in “times”• Materials Consumed = Opening Stock + Purchases –

Closing Stock• Average Stock = ½ (Opening Stock + Closing Stock)• Days of Inventory = 365 / Inventory Turnover Ratio• Can be computed for stock categories to determine fast

moving, slow moving, dormant or obsolete stock• Ideal level is determined with reference to level of other

firms or the industry average

Other Techniques

• Two Bin System – Bin has two parts, the smaller one for reorder stock level and the other for the remaining material

• Issues are made from the larger bin, fresh order placed when it become empty, material used from smaller bin till replacement received and filled

• Periodic Inventory System – Physical stock taking done periodically, requiring shut down

• Records then physically reconciled• Perpetual Inventory System – Records updated at every

receipt and issue• Done using bin cards and stores ledger• Continuous stock taking done by random checks of the

bin cards and stores ledger

Labour Cost

Fundamentals

Meaning

• Essential factor of production

• A human resource that participates in the process of production

• Two Categories – Direct & Indirect Labour

• Labour Cost controlled by:– Personnel Department

– Engineering / Work Study Department

– Time Keeping Department

– Payroll Department

– Cost Accounting Department

Labour Cost Control

• Manpower requirement assessment

• Time and Motion Study

• Job Evaluation and Merit Rating

• Labour Productivity

• Wage Systems

• Incentive Systems

• Time Keeping and Time Booking

• Labour Turnover

• Casual and contract workers

Time Keeping

• Statutory attendance record• Maintain discipline and punctuality• Payroll preparation• Ascertain Overtime• Ascertain Idle Time• Ascertain Labour Cost• Provide basis for apportionment• Control Labour Cost• Maintained using Attendance Register / Muster,

Token / Disc Method and Time Clocks / Clock Card

Time Booking

• Records time spent by each worker on various jobs / orders / processes

• Methods:

• Daily Time Sheet

• Weekly Time Sheet

• Job Card or Job Ticket

• Time and Job Card

• Labour Cost Card / Circulating Job Card

• Piece Work Card

Labour Turnover

• Rate of change in the composition of labour force due to retirement, resignation or retrenchment

• Defined as the number of workers left or replaced or both in relation to the average number of workers

• Turnover due to personal, avoidable and unavoidable causes

• Cost of Labour Turnover consists of Preventive Cost and Replacement Cost

• Preventive Cost – personnel administration, medical & health care, welfare measures, wage & retirement benefits

• Replacement Cost – personnel department expenses, training of new workers, initial inefficiency, initial breakages and defectives, time lag in recruitment,

Labour Turnover Measurement

• Measurement by Separation Rate Method, Replacement Rate Method, Flux Method

• Separation Rate Method: Number of Separations / Average Number of Workers x 100

• Replacement Rate Method: Number of Replacements (not normal additions) / Average Number of Workers x 100

• Flux Method: (Number of Separations + Replacements) / Average Number of Workers x 100

OR

(Number of Separations + Accessions i.e. all Recruitments) / Average Number of Workers x 100

Types of Labour Cost

• Overtime Cost:– Customer requested, charged to specific job– For increased production, charged to total production– Abnormal overtime, charged to Costing P&L Account

• Idle Time:– Normal Idle Time, charged to the product– Abnormal Idle Time, charged to Costing P&L Account

• Casual Workers, charged to specific job or as production overhead based on work done

• Out-Workers (who do the work in their premises) normally supply based on piece rate

• Outside Workers (outdoor duty) should be monitored to ensure adequate time booking

Types of Labour Cost

• Attendance Bonus are part of wages and treated accordingly

• Shift Premium, charged same as Overtime Cost

• Fringe Benefits are part of wages and treated accordingly

• Apprentice Wages, charged as production overhead

• Holiday / Vacation Pay, charged as overhead or accounted in an inflated rate

• Leave with pay, accounted in an inflated rate

• Employer’s contribution to employee insurance, charged as production overhead

Incentive Wage Plans

• Premium Bonus Plan - Halsey Plan, Halsey Weir Plan, Rowan Plan, Barth Plan

• Differential Piece Work - Taylor System, Merrick System• Combination of Time and Piece Work - Emerson’s

Efficiency Plan, Gantt Task and Bonus Plan, Points Scheme (Bedeaux Plan, Haynes Plan), Accelerated Premium Plan

• Group Incentive Plans – Priestman’s Production Bonus, Rucker Plan, Scalon Plan, Towne Gain Sharing Plan, Budgeted Expenses Bonus

• Incentives for Indirect Workers• Profit Sharing• Co-Partnership

Premium Bonus Plans

• Halsey Plan: standard time fixed for each work, guarantees hourly wages for actual time taken, bonus of 50% paid if time savedEarnings = Time Rate Wages + Bonus= Actual Time Taken x Time Rate + 50% (Time Saved x Time Rate)

• Halsey – Weir Plan: same as Halsey Plan except bonus is 33⅓% compared to 50% in Halsey Plan

• Rowan Plan: same as Halsey Plan except bonus is a proportion – (Time Saved / Time Allowed) x Actual Time Taken x Time Rate

• Barth Plan: Designed for trainees, beginners and slow workers. Earnings = Time Rate x √(Standard Hours x Time Taken)

Differential Piece Rate System

• Lower and higher production rates are defined• Taylor’s System:

– Production < standard output: Earnings are 80% of normal

– Production = or > standard output: Earnings are 120% of normal

• Merrick’s System:– Production < 83% of standard output: Earnings are

100% of normal rate – Production > 83% and < 100% of standard output:

Earnings are 110% of normal rate – Production > 100% of standard output: Earnings are

120% of normal rate

Combination Plans

• Emerson’s Efficiency System: – Up to 66⅔% efficiency, nil bonus

– More than 66⅔% and < 100% efficiency, bonus on step basis (32 bonus steps defined)

– More than 100% efficiency, bonus @ 20% of basic wages + additional bonus @ 1% for each 1% increase in efficiency

Gantt Task and Bonus System:– Less than standard output, no bonus

– At standard output, 120% of time rate

– More than standard output, 120% of piece rate

Combination Plans

• Bedeaux System or Points Scheme:– Points awarded for each unit of production

– Up to standard time, no bonus

– If time saved, bonus of time saved is given 75% to worker and 25% to foreman

• Haynes System– Job expressed in standard man-minutes

– For repetitive work, time saved is shared between worker and foreman in 5:1 ratio

– For non-repetitive work, time saved is shared between worker, employer and foreman in 5:4:1 ratio

• Accelerated Premium System– Bonus rate increases with output

Group Incentive Plans

• Priestman’s Production Bonus:– Bonus paid in proportion to production in excess of

standard output per week

• Rucker Plan– Also known as Cost Saving Sharing Plan– Bonus = fixed proportion of value added (sales –

purchased materials & services)– ⅔ of the monthly bonus is paid out, balance

transferred to reserve fund

• Scalon Plan– Similar to Rucker Plan except that bonus is linked to

ratio of direct labour cost to sales value

Group Incentive Plans

• Towne Gain Sharing Plan– Bonus calculated as 50% of direct labour

hours saved

• Budgeted Expenses Bonus– Bonus determined as a fixed percentage of

savings in actual expenses over the budgeted expenses

Incentives for Indirect Workers

• For expense and service cost centers

• Creates goodwill, fosters teamwork and increases efficiency

• Measuring or relating indirect work to production is difficult

• Establish standards for measurable and repetitive activities

• Generally clubbed under group incentive plans

• Two Types: Monetary & Non-Monetary

Profit Sharing

• Based on overall business prosperity and is over and above other benefits

• Types: Cash Plan, Deferred Credit Plan, Combined Plan

• Minimum bonus for eligible workers determined under Payment of Bonus Act

• Discretionary bonus for all determined by the management

• Paid on a flat percentage or on slab rates

Direct Expenses

Basics

Examples

• Cost of designs, drawings, technology, royalty, patent fees, tools, jigs, fixtures for the job

• Special services for layout, machining, testing related to the job

• Fees paid to architect, consultant, surveyor, insurance, freight, hire charges for special tools or equipment related to the job, sub-contracting charges

• Generally considered as direct overhead and then allocated to the job or product