What is Labor Cost Control? Mechanism, Attrition, Turnover, Factors Affecting, Recording of Timings

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What is Labor Cost Control?

Labor cost control refers to the management and optimization of the expenses associated with employing and compensating workers within an organization. Labor costs typically represent a significant portion of a company’s overall expenses, and effective control of these costs is essential for maintaining profitability, efficient operations, and a competitive advantage. Labor cost control involves strategies and practices aimed at maximizing the value of labor while minimizing unnecessary expenses.

In today’s global environment where competitiveness in terms of quality and cost of products assumes a significant role, an efficient management of workforce in relation to the labor cost and increased productivity pose a greater challenge to the business firms.

Therefore, the management accounting professionals should understand the mechanism of labor cost control to optimize the productivity and, at the same time, to keep the workforce satisfied in terms of their compensation and other incentives. Labor costs consist of monetary benefits, deferred monetary benefits and the fringe benefits. Following are the important issues which affect the labor costs to a greater extent.

Classification of Labor Cost

Broadly, the labor cost is bifurcated into two categories, viz. the direct labor cost and the indirect labor cost. Labor cost also includes various remunerations paid to the workers in terms of wages, allowances, provident fund contribution, subsidized benefits, medical facilities, group insurance, etc. The direct labor cost is the amount of remuneration that can be identified and attributed directly to a product or a service unit. It consists of significant amount in the total compensation payable to the workers.

On the other hand, the indirect labor cost is the remuneration payable to the workforce where their skills and contributions are not directly related to the particular product, such as the salaries and wages paid to supervisors, security staff, stores staff, etc.These are common and cannot be specifically allocated to a single product. We can also say that indirect wages are the wages paid to the workers who facilitate the production rather than directly involved in the production process. Apart from this, certain expenditure incurred on account of machine repairing and maintenance, idle time, waiting time, etc., fall under the category of indirect labor costs.

Remember, the direct labor cost payable as wages and salaries are charged directly to the particular job or to a specific product. It is included in the prime cost. Indirect labor costs are the form of overhead cost. Labor cost is also classified as fixed and variable. A direct labor cost is variable in nature and it can be controlled at the discretion of management. There are certain fixed labor costs which cannot be controlled. Indirect labor cost can also be controlled by fixing certain standards for the overheads and controlling them with the actual cost.

Labor Cost Controls

Labor costs can be controlled by recruiting the workers as per the budget, proper time recording systems, allocating standard labor cost for the product or job and proper maintenance of job profile of individual employees.

Process and Production Planning

A firm can achieve sufficient control by properly planning the production process in a more scientific manner. The production process planning may involve activities like planning, scheduling, routing, machine loading, product and process engineering, work study through well laid-down norms. The important mechanism in this is time and motion study which helps in fixation of standard time for a particular job. Once the standards are fixed, monitoring process becomes easy to analyse the actual costs with the predetermined standards.

Labor Budget

A firm prepares various budgets to have an effective control on various operations. The labor budget is prepared to forecast the budgeted expenditure on workforce activities like recruitments, wages and salaries and other remunerations. It helps in budgetary control. At the end of the particular time period, an analysis can be made to assess the variances between budgeted levels and actual costs under different components.

Standard Labor Cost

A firm may also determine the standards of labor cost on per unit basis to compare with the actual labor cost. The standard labor cost is the cost, which is determined based on the past trends, industry practices, technological aspects, etc. This is determined under optimum working conditions and helps a firm to adhere adequate control in the future. The standards can also be fixed based on time and motion study. This has been an effective way to monitor and control the labor costs.

Job Performance Report

A firm may also introduce individual job performance report which can be used for performance evaluation periodically. This will indicate labor efficiency and time utilization by the individual workers. This will be helpful in measuring the efficiency and productivity of the individual workers.

Work Performance Incentives

The incentives relating to work performance also play a major role in the productivity improvement of the workers. There are two aspects in it: one is the costs and the other is the increased productivity. A firm has to decide the extent of incentives which brings efficiency in the production process and compare it with the additional costs on such incentives.

Improving the labor productivity is one of the important ways to reduce the labor cost per unit. In this area, the firm may introduce both the monetary and the non-monetary incentives. There has to be a periodic review of the incentive schemes to make required changes from time to time to bring in more efficiency.

Mechanism of Labor Cost Control

There is a proper mechanism which needs to be set up in a firm involving different departments, such as personnel, human resources development, engineering and accounting. These departments perform specific tasks related to the workers performance and productivity.

Personnel Management Department

The role of personnel management department is very significant in designing the policies and systems to the workers in such a way that they contribute to their maximum capacity. This department is basically responsible for activities like recruitment, training, transfer, promotions, termination, designing and developing various incentive schemes and maintaining personal records of the workforce. In fact, the labor cost control mechanism commences right from the point of recruitment of workers where adequate care should be taken to employ the workers according to the requirement matching with the experience and qualification.

Labor Attrition

This is also known as labor turnover. In other words, we can say the frequency of labor exit from one industry to another. This is a major problem, particularly in the factories. The workers have tendency to change the job frequently. The labor turnover can be defined as a change in the labor force as compared to the total labor force. Labor attrition is prevalent in all types of industries, but the degree of change may differ from one industry to another.

Labor turnover is the rate of change in the number of workers and, if this is too high in a particular firm as compared to others, it speaks of inefficient personnel management policies. With the increased opportunities for jobs on account of emergence of new services and products, the labor turnover has been increasing.

For a healthy organization, the labor turnover should not be very high as it will have multidimensional effects on productivity, costs, culture, reputation of the firm, replacement costs, etc. This will also increase the costs of induction and other training programs. Therefore, a well-organized firm ensures that the labor turnover is minimum. However, a little degree of labor turnover is desired to replace certain workers and induct new workers to bring innovations and efficiencies in the process.

Measurement of Labor Turnover

It is necessary to measure the labor turnover rate from time to time to frame suitable policies to control higher turnover ratio. Following are the methods which help in the measurement of labor turnover.

Addition Rate

Under this method, a number of employees inducted during a particular time period are considered for the measurement of labor turnover ratio. Following is the formula for computing addition rate:

Labor turnover = Number of additions during the period / Average number of workers during the period ×100

Separation Rate

In this method, the number of employees who left during a particular time period are considered for measuring the separation rate. Following is the formula for measurement of separation rate:

Labor turnover = Number of separations during the period / Average number of workers during the period ×100

Replacement Rate

Under this method, the number of employees replaced during a period is taken into account for computing the labor replacement rate.

Labor turnover on account of replacement = Number of replacements during the period / Average number of workers during the period ×100

Flux Rate

This is a slightly different method whereby labor turnover is computed by considering the additions of workers during the period and also separations during the period. It can be computed through the following method:

Flux rate = { Number of new joining + Number of separations during the period Average number of workers during the period / 2 } / Average number of workers during the period × 100

Remember, the average number is taken as the simple average.

Factors Affecting Labor Turnover

Once the firm is able to measure the turnover ratio, it will find out the causes of turnover. The labor turnover may happen on account of both the internal and the external factors. We will discuss these factors.

Internal Factors for Labor Turnover

The following factors may cause labor turnover due to a firm’s own internal inefficiencies. These causes can be avoided by taking appropriate action by the management.

The main causes among them are as follows:

  • Labor may not be satisfied with the type and process of job.

  • There may be problem with the scheduled working hours which may not be suitable.

  • The working environment prevailing in the factory may not be conducive.

  • Lack of cooperation among the workers.

  • Unhealthy relations with the superiors and management.

  • The remuneration policies may not be suitable as compared to other firms. There may be lack of incentives and motivations.

  • This apart, there may be other causes like inadequate facilities in terms of health insurance, inadequate safety measure, high risk in operations, lack of suitable promotion policy, inadequate arrangements for training and absence of other incentives.

External Factors

There can be many other reasons which may cause high labor turnover and such reasons may not be within the control of management.

The following reasons may fall in this category:

  • Turnover due to retirement, death and other family and personal reasons.
  • Continuous ill health, accident and other physical problems.
  • Location change of a worker.
  • Other social and family circumstances.

Labor Turnover and Its Cost to a Firm

The extent of labor turnover directly affects the cost of a product in a firm. Higher the turnover of labor, higher will be the cost of product to a firm. Therefore, a firm makes all the strategies to have effective personnel policies to minimize the labor turnover. The costs relating to the labor turnover are categorized as preventive and replacement costs. Let us understand this.

Preventive Costs

The labor turnover could be prevented in the beginning itself by designing and framing appropriate policies and strategies. This concept lays importance that prevention is better than cure. The costs incurred for preventing the labor turnover are known as preventive costs. These costs may include cost of personnel management and good administration and involve the expenditure incurred in maintaining good relationships between the management and the workers.

There may be certain extra costs which may also be required to incur, such as provision for better medical facilities, subsidized canteen facilities, recreation facilities, etc., that motivate the workers. There may also be additional expenditure which may be required to incur on other welfare measures like sports facilities, transport, housing, etc. A firm may also have to make provisions for pension, gratuity schemes and other post retirement benefits.

Replacement Cost

This cost occurs on account of getting a replacement for the workers who left the organization for any of the reasons. The cost involved with replacing an existing worker is called replacement costs. This may include the cost of recruitment and training to new workers, loss of output on account of loss in efficiency of the old worker and the new worker, cost on account of increase in wastage and spoilage, loss on account of machine breakage, etc.

In practice, the preventive costs are measured and then apportioned to concerned departments in proportion to the number of persons engaged by each department. Replacement costs arising on account of fault of a particular department are charged directly to the concerned department. In case the labor turnover is due to weak policy of the firm, such cost is treated as an overhead and allocated to the different departments on the basis of number of workers engaged by each department.

Recording of Timings

The proper and accurate time keeping is also very important to monitor the labor cost for the purpose of attendance, calculating wages and salaries, allocation of cost to different jobs and also complying with obligatory requirements. It is undertaken by a separate department known as time keeping office.

This department is mainly responsible for recording the attendance time of each worker accurately. Thus, a firm is able to maintain punctuality and discipline among the workers. This also encourages team spirit and a sense of commitment among the workers. Besides, maintaining accurate timings of the workers is mandatory requirement under the law.

Following is the significance of maintaining proper record of time for each of the worker:

  • The total number of hours worked by each workman can be ascertained for the purpose of calculations of wages, salaries, incentives, etc. This is more relevant in the firms where workers are paid wages as per the time rate plan.

  • This is also required to keep a track on punctuality and discipline among the workers. Each worker remains conscious about the punctuality and timings.

  • There are certain mandatory requirements to receive benefits like pension, gratuity, leave with pay, provident fund, promotion and salary scale on the basis of continuity of service. In that case, attendance records are required to properly verify to ascertain eligibility for such benefits.

  • In cases where the firm follows the policy of overhead allocation based on labor hours, a proper record of time keeping is very much required to measure the exact number of hours consumed for the product.

  • There is also significance of maintaining time records for workers to ascertain the standard time for work and thus calculate the idle time spent by workers. We can also calculate the labor efficiency ratio by maintaining proper time records.

Methods of Time Recording

For proper maintenance of time records, the following methods are generally used by the firms:

Clock Card

Clock card is a method wherein each worker punches the card provided as and when the worker comes in or goes out. The time and date is automatically recorded in the card through the mechanized system. In this process, a new card is prepared and replaced with the old card. This helps in calculation of wages of workers on weekly basis.

In case the wages are paid on monthly basis, the new card is replaced on monthly basis. For this purpose, the firm makes a provision of maintaining two types of racks. One is known as “in-rack” and other is called “out-rack.” When a worker comes in, the card is dropped in the in-rack and when a worker goes out, the card is dropped in the out-rack. The card contains 31 lines or seven lines for monthly and weekly cards, respectively.

The clock card contains the following columns:

  • Name and employee code.
  • Department.
  • Days in case of weekly cards and dates in case of monthly cards.
  • Time in and time out.
  • Total hours (normal hours and overtime hours).
  • Signature of the time keeper.

Following are the advantages of clock card:

  • Preparation of department-wise payrolls.
  • Computation of cost based on time.

Attendance Register or Musters

Under this system, the workers are required to sign manually in the attendance register maintained at the entrance gate and put the time of their arrival and also departure. This system is useful in case the numbers of workers are very small. Moreover, with the advent of technology, now a days, this system is not in much use.

Disc Method

This is one of the traditional methods of recording time where a disc bears the identification number of each worker which has already been allotted to the individual workers. On arrival, the worker picks up the disc from the tray and drops it in the box against the number allotted. This is also followed at the time of exit.

The box is removed at the fixed time. Thus, the time keeper can know the arrival time and late time, if any. This process helps identifying workers reporting on time or late. However, the disc system provides the scope for subjectivity and also difficult to maintain where workers are large in number.

Maintaining of Time Records

There is also a mechanism to record time through a daily time sheet which is maintained for individual worker. This is more useful where workers are engaged in different jobs during the day to measure the timings spent by individual worker on a particular job. The time can be maintained either on a daily basis by the worker where the concerned worker record time on his own or it can also be maintained on weekly basis.

In that case, the worker prepares time sheet on weekly basis about the work performed. There is also a concept of maintaining job ticket. Job ticket is a sheet which is provided to all workers where time for commencing the job is recorded, as well as the time when the job is completed. The job tickets help to ascertain the time taken for each job.

Likewise, there is labor cost card which is used for the job which involves several operations. This is useful for arriving aggregate labor cost of the job or the product. There is also another system called time and job card: This card contains the record of both the time taken for completion of the job as well as the attendance time. This card serves both the purposes.

Methods of Work Study

The workers are compensated in many ways as they need to be motivated in different ways. The extent of incentives depends on their performance of work. Therefore, a firm is required to establish proper work study methods to compensate the workers in judicious manner. Generally, the standards are fixed to complete a job and then it is compared with the actual time taken by the worker to complete the job. There are various methods of work study; we will discuss some of them.

Method Study

The system of method study is used to improve the methods of production and also to achieve the efficient use of the resources like manpower, machines and materials.

Method study has the following features:

  • This method is more appropriate where jobs are complex and operations are costly.

  • It is necessary to have all the related information about a job, like purpose, location, sequence, relationship with other works, methods of working, operators, requirement of skilled workers, facilities required, etc.

  • The working system are modified and redesigned after studying the relevant aspects of the job in details. This may help a firm to change the location and sequence of the work, methods of production and the layout for the job, depending on the study results. This will bring more efficiency, effective way of completing a job and quality improvements.

  • There is need for close monitoring and follow-up to evaluate the modified systems. Thus, method study is more significant for utilizing resources more efficiently and to achieve higher level of production with reduced costs.

Evaluation of Job

The job evaluation is necessary to establish a well-defined wage and salary structure in a scientific manner. Therefore, the appropriate valuation of the job is important. The job evaluation is a technique to analyse and assess jobs to determine their relative value. Thus, a firm can develop a rational and justified approach for differential salaries and wages depending on the job evaluation to the workers.

Following are the main objectives of job evaluation:

  • To develop a systematic and rational wage and job structure.

  • To evaluate a job in more judicious manner to overcome controversies and disputes relating to salary among the workers.

  • To ensure that workers are more satisfied in terms of fair process of compensation.

  • To bring fairness and stability in the wage and salary structure.

  • To make the job evaluation more transparent.

Following are the job evaluation methods generally followed by the firms:

Job Ranking Method

Under this method, jobs are ranked according to the importance on the basis of skills required, education, experience requirements, working conditions, etc. A ranking is done by comparing the other jobs. The different jobs are rearranged in the similar order. The wage, salaries and other compensations are decided on the basis of ranks. This method is simple and can be used when the size of the organization is small.

Point Ranking Method

The jobs under this method are analysed in terms of job factors or characteristics. The job factors may include skills required, efforts involved, working conditions, etc. Thereafter, each job factor is given weight or points based on its value to the job. The jobs are ranked according to the total score and placed under pre-decided grades.

Grade Description Method

As a matter of policy, a firm decides, in advance, certain grades according to education, experience, skills, etc., and the jobs are placed in suitable grade.

Factor Comparison Method

In this case, a firm identifies some key jobs and ranks them according to different factors. The jobs are ranked and evaluated skills, responsibilities, working conditions, etc. The jobs are evaluated and compared with other jobs and a factor scale is constructed.

Merit Rating

In essence, if we see, the job evaluation is concerned with the rating of the job to establish rationality to design wages and salary structure in an organization. The merit rating is the process of comparative evaluation where analysis of merits of individual worker assumes significance. Thus, the merit rating aims at evaluation and ranking of individual worker. This helps in designing and implementing rational promotional policies.

The objectives of merit rating include the following:

  • To evaluate merit of workers for promotion, increment, reward and other incentives.

  • To establish and develop a wage system and incentive scheme.

  • To identify and allocate an appropriate and suitable job for the workers.

  • To develop a self-designed system enabling a worker to evaluate own merits and identifying areas needing improvements and developing capabilities and competencies.

  • To develop an inbuilt system to promote cooperation, quality of work, punctuality and regularity, skill development, etc.

Time and Motion Study

The time study is an important technique which establishes time for a worker to carry our particular elements under specified conditions at a defined rate of working recorded by direct observation of time using a time measurement device to rate individual elements. This helps to design efficient incentive systems. Time study measures the time needs to be spent on the job as per the pre-determined standards. However, for determining the standard time, motion study is essential.

The motion study precedes the time study. Motion study can be explained in terms where a job is divided into fundamental elements or basic operations to study in detail the elements and avoid undesired elements. Under this study, a detailed investigation is made to study all movements in a job, process or operation and find out the most scientific and systematic approach of performing the job. The standard time is fixed giving due consideration to normal idle time.

The objectives of time and motion study are as follows:

  • Bringing more efficiency in the production process by removing undesired motions in the process.

  • Designing and developing improved methods, techniques and processes for completing the job.

  • Effective and efficient utilization of resources.

  • Developing conducive work environment through proper layout of plant.

Advantages of Motion Study

A well-designed motion study will have the following advantages:

  • Proper assessment of labor requirement.

  • Promoting incentive systems by fixing suitable standard time.

  • More realistic labor budget and production budget.

  • Bringing improvements in labor productivity by designing more scientific method for job performance.

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