CHAPTER 3 ACCOUNTING FOR LABOR

Review Summary
1. Direct labor, also known as “touch labor,” consists of the workers who physically convert raw
materials to finished goods. It is the portion of payroll cost traced directly to the product, and is
charged to the work-in-process account. Indirect labor consists of all other labor involved in the
manufacturing process and is charged to the factory overhead account. Accounting for labor
involves: recording the time worked and/or the quantity of output by the employee; analyzing
employees’ time to determine how time is to be charged; allocating the factory labor costs to the
proper accounts; and preparing the payroll.
2. Under an hourly-rate wage plan the employee’s wages are computed by multiplying the
established hourly rate times the hours worked. Although widely used and easy to apply, it doesn’t
provide any incentive to achieve a high level of productivity. Under a piece-rate plan, earnings
are based on a worker’s quantity of production. Such a plan provides an incentive for the worker
to produce a high level of output, but it may encourage sacrificing quality for quantity, and it is
not appropriate if machines control production speed. A modified wage plan combines some
features of hourly-rate wage plans and piece-rate plans in that it may set a minimum wage that
will be paid even if an established quota is not met, while an additional payment for each piece
beyond the established quota is added to the minimum rate.
3. The timekeeping function is responsible for determining the number of labor hours that the
company should pay for and the type of work that the employees performed. Automated
timekeeping technology, using magnetic cards and card readers, sends labor time information to
the accounting department for the preparation of the payroll and the distribution of labor costs to
jobs. The payroll function is responsible for computing employee gross earnings, deductions, and
net pay. Payroll maintains the payroll record and the employee earnings record. A payroll record
provides information for all employees for one pay period relative to pay rate, hours worked,
regular and overtime earnings, deductions, and net pay. The employee earnings record is a
record of the cumulative earnings for a single employee for the entire year used to compute the
amount of earnings subject to payroll taxes. It also serves as the basis for reporting payroll
information to governmental agencies and preparing W-2’s.
4. The labor cost summary form is prepared from the labor time records, and it is used for the
preparation of a general journal entry that distributes the payroll to the proper accounts. Work in
Process is debited for the regular-time wages of direct labor, Factory Overhead is debited for
indirect wages and Payroll is credited for the total. The additional rate added to a direct labor
employee’s regular rate for overtime worked is the overtime premium. If the overtime work on a
particular job resulted from random scheduling, then the overtime premium should be charged to
Factory Overhead and spread over all jobs; whereas if the overtime resulted from the unique
demands of a specific job, then the overtime premium should be charged to Work in Process and the
particular job that caused its incurrence. The regular rate is charged to the jobs on which the
employee worked.
5. Payroll taxes imposed on employers include social security tax and federal and state
unemployment taxes. The Federal Insurance Contribution Act (FICA) requires employers
to pay social security and Medicare taxes on wages and salaries equal to the amount of tax
withheld from employee’s earnings. The Federal Unemployment Tax Act (FUTA) requires
employers to pay an established rate of tax on wages and salaries to provide for compensation to
employees laid off from their jobs. Employers’ contributions are apportioned between the federal
government, which administers the unemployment compensation program,

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 and the state governments, which actually pay out the benefits. Since payroll tax rates and wage
bases frequently change, this text assumes an 8% tax rate on the first $100,000 of FICA wages, and
a 4% rate for state taxes and a 1% rate for federal taxes on the first $8,000 of wages for
unemployment compensation. Theoretically, payroll taxes should be charged to accounts where the
related labor was charged; however, it is usually more practical to record all factory related payroll
taxes as Factory Overhead.
6. When the financial statement date does not coincide with the ending date for a payroll period, an
accrual for payroll earnings and the employer’s portion of payroll taxes should be made to avoid
understating the expenses and liabilities for the period.
7. Shift premiums may be paid to employees who do not work the regular day shift. Because these
premiums are paid for inconvenient hours rather than increased productivity, they should be charged
to Factory Overhead and allocated to all jobs, rather than to Work in Process, to avoid distorting the
cost of certain jobs. Defined benefit pension plans determine benefits based on an employee’s level
of income and length of service. Defined contribution pension plans, such as 401 (k) plans, specify
the maximum contribution that can be made to an employee’s account during the year, but the
amount of pension benefits is based on the performance of the investment vehicles that the employee
selected. Non-contributory plans are completely funded by the company, whereas contributory
plans, which are more common, require a partial contribution from the employee. The company
should accrue, systematically, the total estimated pension cost from the date the plan started to the
date the employee retires. Current pension costs for factory employees are part of the cost of
production and may be charged to Factory Overhead, or they may be charged to General
Administrative Expense under the premise that the costs of pensions are beneficial to the company as
a whole. Bonus pay, vacation pay, and holiday pay are considered to be earned gradually during
the employee’s time on the job, and therefore a portion of this liability is accrued each payroll period
that the employee is on the job.

Part I
Instructions: Indicate your answer in the Answers column by writing a “T” for True or an “F” for
False.
Answers
1. The cost of direct labor is charged to the factory overhead account...............
_________
2. A serious limitation of a piece-rate wage plan is that no incentive is provided by
the plan design to maintain a high degree of employee productivity...............
_________
3. The payroll function includes completing and maintaining the payroll records
and the employees’ earnings records.............................................................
.................................................................................................._________
4. The payroll accrual computation should not include the employees’ withholdings
.................................................................................................._________
5. Non-contributory pension plans are completely funded by the employer........
.................................................................................................._________
6. The employee earnings record contains the earnings history for a single
employee, whereas the payroll record shows the earnings data for all employees
for a specific payroll period.........................................................................
.................................................................................................._________

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Chapter Three Name ________________________________________
7. The debit posted to Factory Overhead for payroll costs represents the indirect
labor cost recorded in the factory overhead ledger.........................................
.................................................................................................._________
8. If the overtime hours incurred on a job were merely the result of random
scheduling, the cost of the overtime premium should be charged to the specific
job worked on during the overtime period.....................................................
.................................................................................................._________
9. Employers and employees share equally the cost of the social security program.
.................................................................................................._________
10. In theory, payroll taxes on factory direct labor should be charged to Work in
Process as direct labor, but in practice they usually are included in Factory
Overhead.....................................................................................................
_________
11. The unemployment insurance program is administered by the federal
government, but the individual states make claims payments........................
_________
12. Shift premiums usually are charged to Factory Overhead in order to avoid a
substantial distortion of costing of jobs due to differences in worker productivity.
_________
13. In a modified wage plan, a make-up guarantee is paid when an employee works
fewer hours than recommended to produce the established quota..................
_________
14. Defined benefit pension plans specify the exact amount of retirement income that
an employee will receive..............................................................................
_________
15. The costs of vacation pay and holiday pay should be accrued in the periods that
the employees actually work........................................................................
_________

Part II
Instructions: In the Answers column, place the letter from the list below that identifies the term that
best matches the statement. No letter should be used more than once.
a. Payroll function h. Hourly-rate plan o. Federal Insurance
b. Payroll record i. Indirect labor Contribution Act
c. Defined contribution plans j. Federal Unemployment p. Piece-rate plan
d. Direct labor Tax Act q. Magnetic card reader
e. Employee earnings k. Defined benefit plans r. Payroll taxes
record l. Non-contributory plans s. Bonuses, vacations,
f. Contributory plans m. Modified wage plan and holiday pay
g. Bar codes n. Shift premium t. Timekeeping
function
Answers

_____ 1. This is the labor charged to the product by a debit to the work-in-process account.
_____ 2. This consists of all other types of labor used in the manufacturing process and is charged
to the factory overhead account.

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_____ 3. This is a widely accepted wage plan that is simpler to use than other plans.
_____ 4. Under this type of wage plan, earnings are based on the worker’s quantity of production.
_____ 5. An example of this type of plan would be a set minimum wage plus an additional payment
per piece if the established quota is exceeded.

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Chapter Three Name ________________________________________

_____ 6. The responsibilities of this area include determining the number of hours that the company
should pay for the type of work the employees performed.
_____ 7. This area is assigned the responsibility of computing each employee’s gross earnings, the
amount of withholding, and the net pay.
_____ 8. These are pension plans whose retirement benefit payments are based on the performance
of the investment vehicles chosen by the employees.
_____ 9. This becomes the mechanism by which timekeeping data is transferred to a remote
computer terminal.
_____ 10. Even though these are received at specific times during the year, their costs are accrued
throughout the year.
_____ 11. This is a summary listing of employees’ earnings for a payroll period and includes
such items as FICA taxable earnings, deductions, and net amount paid.
_____ 12. This is a record of the cumulative earnings of each employee.
_____ 13. These are symbols that can be processed electronically to identify numbers, letters, or
special characters.
_____ 14. These are pension plans that require a partial contribution by the employees.
_____ 15. These are imposed on employers and include social security tax and federal and state
unemployment taxes.
_____ 16. It requires employers to pay social security taxes on wages and salaries equal to the
amount withheld from employee earnings.
_____ 17. This requires employers to pay an established rate of tax on wages and salaries to provide
for compensation to employees if they should be laid off from their regular jobs.
_____ 18. This usually is added to the regular rate of pay for employees who do not work a normal
day shift.
_____ 19. These are pension plans that specify the amount of benefits that an employee will
receive based on earnings and length of service.
_____ 20. These are pension plans that are completely funded by the company.

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 Part III
Instructions: In the Answers column, place the letter of the choice that most correctly completes
each item.
Answers

_____ 1. A modified wage plan:

a. Usually results in less total wages than an hourly- rate plan
b. Is riskier from an employee’s viewpoint than a piece-rate plan
c. Directs management’s attention to the employees unable to meet quotas
d. Has a make-up guarantee when an employee’s production exceeds the
quota
_____ 2. The document that provides evidence of an employee’s total time in the plant is
the:
a. Labor time record c. Labor cost summary
b. Daily performance report d. Requisition
_____ 3. An example of a fringe cost is:
a. The direct labor wage rate
b. Withheld taxes
c. Union dues paid by the employee
d. The employer portion of FICA tax
_____ 4. The wage plan which most bases an employee’s earnings on the quantity of the
employee’s production is termed a(n):
a. Hourly rate plan c. Piece-rate plan
b. Modified wage plan d. None of the above
_____ 5. In job order costing, payroll taxes paid by the employer for factory employees are usually
accounted for as:
a. Direct labor c. Work in process
b. Factory overhead d. Administrative costs
_____ 6. When a rush order is received during the week and it must be completed during an
overtime shift, the overtime premium is charged to:
a. General and Administrative Expenses
b. Accrued Overtime Premium Receivable
c. Factory Overhead Control
d. The job worked on during the overtime period

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Chapter Three Name ________________________________________

_____ 7. An employee is paid a base rate of $800 per week for 52 weeks. The employee is entitled
to a four-week vacation each year. Factory Overhead Control is debited each week for
accrued vacation pay of:
a. $64.00 c. $61.54
b. $0 d. $66.67

_____ 8. To spread the cost of an annual bonus over production throughout the year, the weekly
payroll entry would include a debit to which of the following accounts for the bonus
portion of the entry?
a. Work in Process
b. Factory Overhead
c. Payroll
d. Liability for Bonus
_____ 9. All of the following items are included as accrued expenses when the accounting period
does not correspond with the payroll date except:
a. Indirect labor wages
b. Overtime premium
c. Employee withholdings
d. Employer payroll taxes
_____ 10. Robert Nester works at Marley Manufacturing Company. Last week, Robert, who earns
$20 per hour, and time-and-a-half for overtime, worked 48 hours. Of those hours, he
spent 36 hours working on Job 325Y and the remainder doing preventive maintenance on
the lathe machinery. The amount of Robert’s pay charged to Factory Overhead last week
would have been:
a. $960
b. $320
c. $240
d. $80

Part IV
Computing earnings with incentive compensation.

B. Arroyo, an employee of the Cincinnati Cabinet Co., submitted the following data for work activities
last week:
Day Units Produced Each Day
Monday.................................... 30
Tuesday.................................... 32
Wednesday................................ 46
Thursday.................................. 28
Friday....................................... 34
During the week, Arroyo worked eight hours each day. Compensation was based on a modified wage
plan where an employee earns $2.50 per finished unit and is guaranteed a minimum of $10 per hour.

Instructions: Complete the schedule below. (Round labor cost per unit to the nearest whole cent.)

Earnings at Piece-rate Make-up Daily Labor Cost

Day $10 per Hour Earnings Guarantee Earnings per Unit

Monday __________ __________ __________ __________ __________

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Tuesday __________ __________ __________ __________ __________
Wednesday __________ __________ __________ __________ __________
Thursday __________ __________ __________ __________ __________
Friday __________ __________ __________ __________ __________

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Chapter Three Name ________________________________________

NOTE: Unless otherwise directed, use the following rates in the remaining parts of this chapter:
FICA tax, 8%; FUTA tax, 1%; state unemployment insurance tax, 4%. Assume also that the base wage
amounts, beyond which taxes are not due, have not been reached.

Part V
Computing and journalizing payroll.

The information below, taken from the daily time tickets of Musketeer Manufacturing, Inc.,
summarizes time and piecework for the week ended January 30.
Clock Job Hours Production Hourly Piece
Employee No. No. Worked Pieces Rate Rate
Frease, K............... 37 347 40 780 – $.50
Redford, B............. 38 – 40 – $ 7.00 –
McLean, J............. 39 343 46 –   8.80 –
Love, J.................. 40 – 40 –  12.20 –

The company operates on a 40-hour week and pays time and a half for overtime. FICA tax deductions
should be made for each employee. A 3% deduction is to be made from each employee’s wage for health
insurance. Redford works as a forklift operator; Love is the supervisor; the others work directly on the
jobs. Use 15% in computing income tax withheld.

Instructions:
1. Using the form provided below, determine each employee’s gross pay, deductions, and net pay.

Frease Redford McLean Love Total

Hours worked...................
Piecework........................
Rate (hourly/piece)...........
Direct labor......................
Indirect labor....................
Overtime premium............
Gross pay......................... $ $ $ $ $
Income tax (15%)............. $ $ $ $ $
FICA tax (8%).................
Health insurance (3%)......
Total deductions...............
Net pay............................ $ $ $ $ $
2. Prepare journal entries to (a) set up the accrued payroll and other liabilities, (b) pay the
payroll, (c) distribute the payroll, and (d) record the employer’s payroll taxes.

Account Debit Credit

34
(a)

(b)

(c)

(d)

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Chapter Three Name ________________________________________

Part VI
Accounting for overtime pay.

An employee of the Assembly Department is paid $20 per hour for a regular week of 40 hours. During the
week ended July 15, the employee worked 50 hours and earned time and a half for the overtime hours.

Instructions:

1. Prepare the entry to distribute the labor cost if the job worked on during overtime was a rush
order, the contract price of which included the overtime premium.

Account Debit Credit

2. Prepare the entry to distribute the labor cost if the job worked on during overtime was the
result of random scheduling.

Account Debit Credit

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 Part VII
A production worker earns $4,400 per month and the company pays the worker a year-end bonus equal
to one month’s wages. The worker receives a one-month paid vacation per year and 10 paid holidays
per year. Bonus, vacation benefits, and holiday pay are treated as indirect costs and accrued during the
11 months that the employee is at work.

Instructions: Prepare the journal entry to distribute the payroll and the costs and liabilities
associated with the bonus, vacation pay, and holiday pay of the production worker for a month.

Account Debit Credit

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