Planning and Controlling Direct Labor Costs - Essay Example

? Planning and Controlling Direct Labour Costs Grade Outline Introduction……………………………………………………………………...….………..3 Importance of the study…………………………………………………………….….……..3 Analysis………………………………………………………………………...…….………4 Conclusion……………………………………………………………………...…….………7 References……………………………………………………………………………..……..8 Introduction One of the issues commonly discussed in most boardrooms is the need to cut costs. In the current competitive business environment, companies that cannot afford to charge low prices on their products are likely to be excluded from markets. In this regard, cost cutting allows firms to employ low pricing strategy and still make profits (Burns, Quinn, Warren & Oliveira, 2013). Business costs come in many forms. As noted by Burn et al. (2013), manufacturing companies incur expenses in acquisition of raw material and labour among other things. Sometimes it is not easy to assess the value contributed to the company’s product or service by the expenses incurred. According to Burn et al. (2013), many firms find it hard to assess actual contribution of their employees to their products. In this regard, planning and control of direct labour costs is one of the most challenging tasks for businesses. This paper discusses direct labour costs in relation to a soda ash mining company called Tata Chemicals Magadi. Importance of the study Tata Chemicals Magadi has been experiencing financial difficulties in the recent years. As a result, the company hired an expatriate in May this year to help streamline its operations. After analysing the company’s operations, Paul Patterson (the expatriate) asserted that the Magadi’s financial problems were mainly caused by poor planning and control of labour costs. He therefore proposed a plan to improve labour efficiency. He took office in July 2013 but his progress has never been assessed until today. This study aims at determining the extent to which Patterson has been successful in streamlining the company’s direct labour costs. The specific objectives include: (1) determining actual contribution of individual employees to product output in the months of September, October and November. (2) Reconciling variances and providing information that will help the company to properly plan and control its direct labour costs. (3) Enhancing maximum output from employees. Analysis Direct labour cost comprises of human resource expenses that goes directly to processing of products or provision of services (Horngren, Datar & Foster, 2003). In a manufacturing set up, direct labour cost would be the expenses incurred in form payment of wages and other benefits to employees who are directly involved in product manufacturing (Horngren, Datar & Foster, 2003). In this regard, as pointed out by Horngren et al. (2003), benefits may range from house allowance, transport allowance, medical cover, social security contribution and workmen’s compensation insurance among other things. This excludes labour expenses related to administrative functions such as accounting, human resources and purchases departments. Some functions in manufacturing department such as supervision and other overhead costs are not part of direct labour costs (Horngren et al., 2003). Tata Chemicals Magadi mines and dries soda ash from Lake Magadi before packaging and transporting to the market. In this case, direct labour costs comprise of wages and other benefits enjoyed by employees who are directly involved in mining and drying of soda ash. There are seven plant operators in charge of mining machines and 22 in charge of driers. In addition, there are 6 drivers who operate tracks that transport wet ash from the lake to the drying plants 4 in charge of front-end loaders at mining and drying sites. Although hourly wages for different employees differ on the basis of experience and skills, Tata Chemicals Magadi has set average wages for its manufacturing department at 10 dollars per hour. Employees also enjoy housing allowance of 15 percent and transport allowance of 10 percent of their basic pay. In addition, the company contributes $1 per hour to employees’ social security and $1.5 per hour for their medical insurance. There is also employment tax of $1.5 for each employee. House allowance per hour = (15/100) * 10 = $1.5. Transport allowance per hour = 10/100 * 10 = $1. Social security per hour = 1.5. The standard direct labour cost per hour = 10 + 1.5 + 1 + 1.5 + 1.5 = $15.5 (Maher, Lanen & Rahan, 2005). The standard labour cost for the month of September is determined as follows. The number of bags of soda ash produced = 43,200, the standard hours for production of each bag = 0.017. Therefore, total standard hours for direct labour = 43,200 * 0.017 = 720. Standard cost per direct labour hour = $15.5. This implies that the standard direct cost in production of soda ash = 15.5 * 720 = $11,160.02 (Maher, Lanen & Rahan, 2005). From the records, the company used 800 actual hours of direct labour with an hourly rate of $15. These results are not good for the company because there was an increase of production hours by 80 from the standard of 720 to actual of 800. When the extra 80 hours are multiplied by the standard rate of $15.5, it gives an undesirable direct labour efficiency variance of -1,240 US Dollars. It should be noted that the direct labour hourly rate reduced from the standard of $15.5 to actual of $15; a reduction of $0.5. Therefore, the actual direct cost = 800 * 15 = $12,000 and the direct labour rate variance = 800 * (15.5 – 15) = 800 * 0.5 = $400. In this regard, the total direct labour cost variance = rate variance + efficiency variance = 400 + -1,240 = $-840. This is unfavourable because it implies that the company is using more on labour than the standard cost (Maskell & Baggaley, 2003). In the month of October, the standard cost per direct labour hour remained the same as the month of September except for additional $2 for training of plant operators. This increased direct labour cost per hour to 15.5 + 2 = $17.5. The company produced 44,000 bags of soda ash and the standard duration for production of each bag was 0.015 hours; implying that the total hours for direct labour was, 44,000 * 0.015 = 660. Since the standard cost per hour for the month was $17.5, the total direct labour cost was, 660 * 17.5 = $11,550 (Maskell & Baggaley, 2003). From the records, the company used 730 actual hours of direct labour with an hourly rate of $16.5. Clearly, the process is still inefficient because the company used more actual hours in production than anticipated. The duration increased from the standard of 660 to actual of 730; an addition of 70 hours. Multiplying -70 by the standard rate of $17.5 we obtain an undesirable direct labour efficiency variance of $-1,225. Although it is still unfavourable, there is a slight improvement from the September value of $-1,240 (Maskell & Baggaley, 2003). The direct labour hourly rate reduced from the standard of $17.5 to actual of 16.5; a decrease of $1. This yields a favourable direct labour rate variance of 730 * (17.5 – 16.5) =730 * 1 = $730. It should be noted that there is a significant improvement from the month of September which was $400 in favour of the company. The total direct labour cost variance for the month of October comes to, -1,225 + 730 = $-495. Although this is still negative, there is a significant improvement from September which had a total cost variance of $-840 (Maskell & Baggaley, 2003). In the month of November, the standard cost per direct labour hour was $15.5. The company produced 44,100 bags of soda ash and the standard duration for production of each bag was 0.014 hours. This implies that the total hours for direct labour were, 44,100 * 0.014 = 617.4. Since the standard cost per hour for the month was $15.5, the total direct labour cost was 15.5 * 617.4 = $9,569.70 (Maskell & Baggaley, 2003). From the records, Tata Chemicals Magadi used 669 actual hours of direct labour at a rate of 14.4 per hour. The process is still inefficient because the company used more hours of production than the standard hours. The duration increased by 51.6 hours. Multiplying -51.6 by the standard rate of $15.5, we obtain an unfavourable direct labour efficiency variance of $-799.80. It should be noted that although this is still a negative value, there is a significant improvement from the month of October (Weetman, 2006). The direct labour hourly rate reduced from the standard of $15.5 to actual of 14.4; a decrease by $1.1. This leads to a desirable direct labour rate variance of 669 * (15.5 – 14.4) = 669 * 1.1 = $735.9. There is a slight improvement from the October value. Therefore, the total direct labour variance for November is -799.8 + 735.9 = $-63.9 (Weetman, 2006). Conclusion The ability to manage costs well is crucial to business success. In this regard, Tata Chemicals Magadi needed urgent intervention to prevent imminent collapse. From the analysis done for the months of September through to November, Paul Patterson has managed to bring some efficiency in the company in relation to direct labour management. The company’s direct labour efficiency variance improved from $-1,240 in September to $-799.80 by the end of November 2013. Although the value is still negative, the established trend reveals that a positive value is likely to be realized within the next three months. On the other hand, direct labour rate variance improved from $400 in September to $735.9 by the end of October. The company’s total direct labour cost variance improved from $-840 in September to $-63.9 by the end of October. Although this is a negative value, the established trend reveals that a positive value is likely to prevail in the next one month. In this regard, I recommend that Paul Patterson continues with his strategies. References Burns, J. Quinn M., Warren L. & Oliveira J. (2013). Management Accounting, McGraw-Hill, London. Horngren, T. C., Datar S. M. & Foster G. (2003). Cost Accounting - A Managerial Emphasis, 11th ed. London: Prentice Hall. Maher, M. W., Lanen W. N. & Rahan, (2005). Fundamentals of Cost Accounting, Ed. London: McGraw-Hill. Maskell, B & Baggaley B. (2003). Practical Lean Accounting. New York: Productivity Press. Weetman, Pauline (2006). Financial and Management Accounting. London: Pearson Education. Read More