Labour is the second element of cost, and in many businesses it is the one managers find hardest to control. Pay is more than a wage packet: it includes overtime, bonuses, pension contributions and benefits. Some of it can be traced to a product and some cannot. The method used to pay people also changes how hard they work and how predictable the labour bill is.
This topic sets out what makes up labour cost, how to decide whether it is direct or indirect, how idle time and overtime are treated, how labour time is recorded, and the main ways of paying employees: by time, by output and by incentive schemes. Expect a calculation of pay under one or two methods, and a discussion of advantages and limitations.
In 30 seconds
Labour cost covers basic pay, overtime, bonuses, employer contributions, fringe benefits, training and welfare. The basic pay of workers for hours spent on production is direct labour. Idle time, most overtime premium, training hours and the pay of indirect staff are indirect labour and go into overheads. Overtime premium is direct only if the overtime is worked at a particular customer’s request.
Labour is recorded using payroll records and time sheets. Pay methods are time-based (hours × rate), piecework (units × rate, sometimes with higher rates at higher output and a guaranteed minimum) and incentive schemes (bonuses for higher productivity, for individuals or groups).
What labour cost includes
The total cost of employing someone is wider than their basic wage. The syllabus lists seven parts.
| Component | Meaning |
|---|---|
| Basic wages and salaries | The fixed pay for normal working hours, whether paid by the hour, day, week or month |
| Overtime | Extra pay for hours beyond the normal hours, often at a higher rate such as time and a half or double time |
| Bonuses and incentives | Performance-related payments meant to motivate, such as production bonuses, attendance bonuses and profit-sharing |
| Employer’s contributions | The employer’s share of statutory pension and social security schemes, such as pensions, health insurance, provident funds and the National Housing Fund |
| Fringe benefits | Non-cash benefits such as free meals, transport, accommodation, a company car, a mobile phone, paid holidays and sick leave |
| Training and development | The cost of workshops, seminars and on-the-job training that build skills |
| Employee welfare | Costs of workers’ well-being and safety, such as medical expenses, safety equipment and recreation facilities |
Direct and indirect labour
Direct labour is the pay of people whose work goes straight into turning materials into finished goods or delivering the core service. The cost can be traced to a specific job or cost unit. Indirect labour is the pay of staff who support production or perform administrative work. It cannot be assigned to one product and is treated as an overhead.
There are exceptions. Even for a direct labour employee, part of the pay can be indirect when time is idle or when overtime is worked.
Idle time
Idle time is time for which employees are paid and available but are not doing productive work because of some disruption. It is a form of labour inefficiency and is classed as an indirect labour cost, because it cannot be traced to any job.
| Cause | Example |
|---|---|
| Equipment downtime | A machine breaks down and operators wait for repair |
| Material shortages | Raw materials arrive late, so the line stops |
| Poor production scheduling | Bottlenecks or poor coordination leave some workers with nothing to do |
| Utility interruptions | A power cut, network failure or water shortage halts work |
| Operational delays | Workers wait for instructions, approvals or decisions |
Idle time usually has adverse financial effects: lower labour efficiency, a higher cost per unit, a lower contribution and sometimes lower morale. It can have occasional benefits too, such as recovery from fatigue, or a chance to carry out training or preventive maintenance. To charge it correctly, idle time must be recorded, normally on time sheets, which also form part of the control over how labour is used.
Overtime premium
Overtime is work beyond contracted hours. The overtime rate is the basic rate plus a premium, so total overtime pay per hour = basic hourly rate + overtime premium. The treatment depends on why the overtime arose.
- If it is worked because workload varies or production demand is unexpected, the premium is an indirect labour cost. Charging it to one job would distort product costs, since that job was merely the one being made at the time.
- If it is worked for a specific customer order, such as meeting an urgent delivery date, the premium may be charged directly to that job, provided it can be traced and is justified by the job requisition.
| Item | Direct labour cost | Indirect labour cost |
|---|---|---|
| Direct labour employees | Basic pay for hours worked on production. Overtime premium only when worked at a customer’s request | Other overtime premium. Pay for idle time. Pay for other hours away from production, such as training courses |
| Indirect labour employees | None | All their labour cost |
Worked illustration
Chinedu is a machinist paid ₦900 an hour. His normal week is 40 hours. In one week he works 46 hours, so 6 are overtime paid at time and a half (₦1,350 an hour). During the normal hours, a power failure left him idle for 5 hours.
- Total pay.
(40 × ₦900) + (6 × ₦1,350) = ₦36,000 + ₦8,100 = ₦44,100. - Overtime premium.
6 × (₦1,350 − ₦900) = 6 × ₦450 = ₦2,700. - Idle time.
5 × ₦900 = ₦4,500 (indirect). - Direct labour.
basic pay for productive hours = (35 normal + 6 overtime) × ₦900 = 41 × ₦900 = ₦36,900. - Check.
₦36,900 + ₦4,500 + ₦2,700 = ₦44,100. ✓
If the overtime had been worked to meet one customer’s order, the premium of ₦2,700 would also be direct, making direct labour ₦39,600 and indirect labour ₦4,500.
Recording labour cost
Labour cost has to be traced to departments, cost centres, jobs or products. The two main sources of information are payroll records and time sheets.
| Record | What it does | When it is needed |
|---|---|---|
| Payroll records | Identify each employee as direct or indirect labour and charge each person’s pay to the department or cost centre where they work | Always |
| Time sheets | Record the time each employee spends on different tasks, jobs or products, including idle time | When employees spend time on more than one cost item, and to cost specific jobs or contracts. They are not needed for a machinist who spends all day on one machine making the same product |
For example, if a direct worker splits time between Product A and Product B, the time sheet tells you what share of the pay belongs to each. In a cost accounting system the direct and indirect labour costs are charged to the right cost centres and cost units. The records form part of the double-entry cost ledger where one is kept.
Remuneration methods
The method of pay affects payroll accounting, how costs are attributed, budgeting and internal control. A good choice supports efficiency, helps manage costs and aligns workers’ motivation with the organisation’s goals. Labour is either a component of prime cost, or, together with overhead, of conversion cost.
Whichever way pay is calculated, labour cost is assigned to cost centres or units on a consistent basis, usually from time records or output records. A worker who spends equal time on two processes has pay split 50:50 between them.
Time-based system
Under a time rate system, basic pay = hours worked × hourly rate. This calls for careful time-keeping so that labour can be charged to jobs, processes or orders. Overtime premium is normally indirect, but it can be direct if it was incurred to meet a specific customer order.
| Advantages | Limitations |
|---|---|
| Predictable cost. The labour bill is easy to forecast, helping cash flow planning and budgets | No incentive. Pay does not rise with output, so effort and reward are not linked and productivity may be low |
| Quality focus. Pay does not depend on volume, so workers can concentrate on doing the job properly | Idle time. Paid time may be wasted, raising cost without raising output and giving adverse efficiency variances |
| Fair pay for time worked. Supports compliance with labour law and avoids underpayment | Higher unit labour cost. Labour behaves like a fixed cost whatever the output, which hurts cost-volume-profit results in labour-intensive work |
| Simple to administer. Payroll is straightforward, with fewer errors and less admin cost | Inflexible. Fixed contracts make it hard to adjust staffing to changes in demand |
| Stable earnings. Employees can plan their finances, which helps retention and satisfaction | Possible complacency. A guaranteed wage can weaken motivation to exceed the minimum |
Piecework
Under piecework, pay is linked to output: earnings = units produced × rate per unit. If a seamstress is paid ₦25 for each shirt hemmed and hems 640 shirts in a week, her pay, and the labour cost of those shirts, is 640 × ₦25 = ₦16,000.
| Merits | Demerits |
|---|---|
| Higher output. Pay moves with output, giving a strong link between effort and reward | Quality may suffer. Workers rush to increase quantity, risking defects and warranty claims |
| Transparent. Workers can calculate their own earnings and see the benefit of effort | Strain. Pressure to produce may cause fatigue, absence and ill health, which can raise indirect labour costs |
| Labour becomes a variable cost. Wage costs follow production, which simplifies budgeting and cuts fixed labour overhead | Unequal earnings. Differences in skill and speed create gaps in pay that may harm team spirit |
| Unstable earnings. Pay falls when schedules, demand or material supplies are disrupted, which can cause unrest |
Differential piecework and guaranteed minimum
In a differential piecework scheme the rate per unit rises as output rises. A worker earns a standard rate up to a threshold and a higher rate on the units beyond it, which rewards extra output. Employers often add a guaranteed minimum wage to protect workers from drops in pay caused by things they cannot control, such as machine failure or material shortages.
If the piecework earnings are lower than the minimum, the minimum is paid.
Example. A worker earns ₦90 per unit for the first 120 units in a week, ₦105 per unit for units 121 to 240, and ₦120 per unit above 240. The weekly guaranteed minimum is ₦18,000.
| Week | Output | Working | Piecework earnings | Paid |
|---|---|---|---|---|
| 1 | 260 units | 120 × ₦90 + 120 × ₦105 + 20 × ₦120 = 10,800 + 12,600 + 2,400 | ₦25,800 | ₦25,800 |
| 2 | 150 units | 120 × ₦90 + 30 × ₦105 = 10,800 + 3,150 | ₦13,950 | ₦18,000 (the minimum) |
Here each rate applies only to the units inside its band. Some schemes apply the higher rate to every unit once the threshold is passed. Read the question to see which is meant.
Incentive schemes
Incentive schemes pay extra for better productivity once agreed targets are met. They aim to increase output without adding staff, which raises output per employee and cuts the labour cost per unit, or to complete a fixed output in less time, which cuts the labour hours per unit. They also encourage employees to feel part of the organisation’s success.
- Individual schemes reward each employee for personal output or quality. If the bonus can be traced to a cost unit, it is a direct labour cost and part of prime cost. Otherwise it is indirect.
- Group schemes reward a team or department for joint results and encourage cooperation. If the bonus cannot be traced to a cost unit, or depends on general performance over a period, it is an indirect labour cost absorbed in production overhead. If it can be traced to a cost unit, it is direct.
Example. A plant makes 2,000 units a week using 1,600 direct labour hours at ₦900 an hour. A scheme pays a bonus of 4% of the hourly rate for every hour worked if productivity improves by 8%, in one of two ways: (i) 8% more units in the same hours, or (ii) the same units in 8% fewer hours.
| Current | Scheme (i) | Scheme (ii) | |
|---|---|---|---|
| Hours | 1,600 | 1,600 | 1,600 × 0.92 = 1,472 |
| Rate per hour | ₦900 | ₦900 × 1.04 = ₦936 | ₦936 |
| Weekly labour cost | ₦1,440,000 | ₦1,497,600 | ₦1,377,792 |
| Units | 2,000 | 2,000 × 1.08 = 2,160 | 2,000 |
| Cost per unit | ₦720.00 | ₦693.33 | ₦688.90 |
The company prefers scheme (ii), which has the lowest cost per unit. The employees prefer scheme (i), because they are paid more in total.
Background: the syllabus does not cover time-saved bonus schemes, but earlier papers set them. In a premium bonus scheme, an employee who finishes a job in less than the time allowed receives a share of the time saved, valued at the hourly rate.
If 40 hours are allowed, 34 are taken and the share is 50% at ₦800 an hour, the time saved is 6 hours and the bonus is 6 × ₦800 × 50% = ₦2,400, in addition to pay for the 34 hours worked.
The ideas in more depth
Choosing a method
| Situation | Suits | Why |
|---|---|---|
| Output is hard to measure, or quality and care matter most | Time rate | Pay does not push workers to rush |
| Output is countable and each worker’s output can be measured | Piecework | Pay follows effort, and labour cost is variable |
| The work is team-based and individual output cannot be separated | Group incentive | Reward is shared, encouraging cooperation |
| Output might be disrupted by factors outside workers’ control | Piecework with a guaranteed minimum | The minimum protects income while keeping the incentive |
Controlling and reducing labour cost
The syllabus points to several practical levers. Record time accurately so that idle time is visible and its causes (breakdowns, shortages, poor scheduling) can be fixed. Schedule production to keep workers busy. Use incentive schemes to raise output per hour or to cut hours per unit. Manage labour turnover, whose costs are covered in the next topic.
Pay by a method that fits the work, so that effort and reward line up.
Why the direct/indirect split matters
If idle time were charged to the job being made when the power failed, that job would look dearer than an identical job made on a good day, and quotations would be distorted. Treating idle time as overhead spreads it across all production, which gives fairer unit costs and shows management the size of the problem.
Worked example: classifying and calculating one worker’s pay
Scenario. A welder is paid ₦1,000 an hour for a 40-hour week. This week she works 48 hours: 40 normal hours and 8 overtime hours at time and a half. Five of the normal hours were idle because of a material shortage. (a) Calculate her total pay. (b) Split it into direct labour, idle time and overtime premium.
(c) Show the direct and indirect labour cost if the overtime was worked specifically to meet a customer’s urgent order.
- Total pay.
(40 × ₦1,000) + (8 × ₦1,500) = ₦40,000 + ₦12,000 = ₦52,000. - Overtime premium.
8 × ₦500 = ₦4,000. - Idle time.
5 × ₦1,000 = ₦5,000 (indirect). - Direct labour.
(basic rate for productive hours): (35 + 8) × ₦1,000 = ₦43,000. - Check.
₦43,000 + ₦5,000 + ₦4,000 = ₦52,000. ✓ - Customer-requested overtime.
The premium becomes direct, so direct labour = ₦43,000 + ₦4,000 = ₦47,000.
Indirect labour remains the idle time of ₦5,000.
Check: ₦47,000 + ₦5,000 = ₦52,000. ✓
Common mistakes in the exam
- Treating the whole overtime payment as indirect. Only the premium is indirect, and the basic rate for the overtime hours is direct if the hours were productive.
- Charging idle time to jobs instead of to overheads.
- Missing the overtime premium exception for a customer’s specific order.
- Forgetting the guaranteed minimum in piecework questions.
- Applying the highest rate to all units in a differential scheme when the question says each rate applies to a band, or the reverse.
- Listing advantages of a method without any limitations, or the reverse, when both are asked for.
- In bonus questions, comparing total cost rather than cost per unit.
Quick revision
- Labour cost: basic pay, overtime, bonuses, employer contributions, fringe benefits, training and welfare.
- Direct: basic pay for productive hours. Indirect: idle time, other overtime premium, non-production hours, all indirect staff.
- Overtime rate = basic + premium. Premium is direct only for a specific customer order.
- Records: payroll records and time sheets (needed when work is split across jobs).
- Time rate: hours × rate. Piecework: units × rate. Differential piecework: higher rates at higher output. Guaranteed minimum protects workers.
- Incentive schemes: individual or group. Traceable bonus is direct, otherwise indirect. Compare cost per unit.
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.
Section A style: multiple choice
Question 1. The cost of time for which employees are paid but have no work to do is classified as:
- Direct labour
- Indirect labour
- Prime cost
- A sales cost
Show the answer
B. Idle time cannot be traced to any job, so it is an overhead.
Question 2. The overtime premium is treated as a direct labour cost when:
- Overtime is worked because of general pressure of work
- Overtime is worked at a specific customer’s request
- Workers are idle
- It is never treated as direct
Show the answer
B. The cost can then be traced to that customer’s job.
Question 3. The basic rate is ₦800 an hour and overtime is paid at time and a half. The overtime premium per hour is:
- ₦200
- ₦400
- ₦800
- ₦1,200
Show the answer
B. The rate is ₦1,200, so the premium is ₦1,200 − ₦800 = ₦400.
Question 4. A worker produces 450 units at a piece rate of ₦35. The earnings are:
- ₦12,850
- ₦15,750
- ₦17,500
- ₦9,000
Show the answer
B. 450 × ₦35 = ₦15,750.
Question 5. A merit of piecework is that:
- It guarantees quality
- Labour becomes a variable cost that follows output
- Earnings never vary
- It needs no records
Show the answer
B. Pay moves with output, which helps cost control.
Question 6. A limitation of a time-based system is that:
- Payroll is complicated
- Pay is not linked to output, so there is no incentive
- Workers cannot plan their income
- It increases quality risks
Show the answer
B. Employees are paid for time whatever they produce.
Question 7. The purpose of a guaranteed minimum wage in a piecework scheme is to:
- Raise the piece rate
- Protect pay when output falls for reasons outside workers’ control
- Eliminate overtime
- Remove the need for time sheets
Show the answer
B. It stabilises income during disruptions such as breakdowns.
Question 8. A scheme pays ₦10 per unit for the first 100 units and ₦12 per unit for units above that. Earnings for 130 units are:
- ₦1,300
- ₦1,360
- ₦1,560
- ₦1,000
Show the answer
B. (100 × ₦10) + (30 × ₦12) = ₦1,000 + ₦360 = ₦1,360.
Question 9. Time sheets are needed when:
- An employee works on one machine on one product all day
- An employee splits time between more than one job or product
- There are no direct labour employees
- Pay is a fixed monthly salary and the work never changes
Show the answer
B. They show how to allocate the labour cost.
Question 10. A group bonus that cannot be traced to a cost unit is treated as:
- Direct labour
- An indirect labour cost absorbed in production overhead
- A selling cost
- A finance cost
Show the answer
B. Only a bonus traceable to a unit is direct.
Section B style: written questions
Question 11 (10 marks). Explain idle time and the overtime premium, and state how each is treated in cost accounting.
Question 12 (20 marks). Gombe Garments Ltd is reviewing how it pays its production staff.
(a) Explain two advantages and two limitations of a time-based system. (4 marks)
(b) Explain two merits and two demerits of piecework. (4 marks)
(c) Explain what a guaranteed minimum wage is and why it is used. (3 marks)
(d) A scheme pays ₦60 per unit for the first 200 units a week, ₦75 for units 201 to 400 and ₦90 above 400, with a guaranteed minimum of ₦15,000 a week. Calculate the pay for a week with 460 units and for a week with 150 units. (6 marks)
(e) Distinguish between individual and group incentive schemes. (3 marks)
A further written question
Question 13 (10 marks). A plant makes 1,500 units a week using 1,200 direct labour hours at ₦800 an hour. A bonus of 5% of the hourly rate for all hours worked will be paid if productivity improves by 10%, either (i) by making 10% more units in the same hours, or (ii) by making the same units in 10% fewer hours. (a) Calculate the weekly labour cost and cost per unit currently and under each scheme.
(8 marks) (b) State which scheme the company and which the employees would prefer. (2 marks)
Model answers
Show the model answer to Question 11
Idle time is time for which employees are paid and available to work but do no productive work because of disruption, such as equipment downtime, material shortages, poor scheduling, utility interruptions or waiting for instructions. It cannot be traced to a job, so its cost is an indirect labour cost charged to overheads.
It is recorded on time sheets so that its size and causes are known and can be controlled.
Overtime premium is the extra amount paid per hour above the basic rate for hours beyond the normal working time (for time and a half at ₦800, the rate is ₦1,200 and the premium ₦400). When overtime arises from general pressure of work or unexpected demand, the premium is an indirect labour cost, because it would be unfair to charge it to whichever job happened to be in production.
When the overtime is worked specifically to meet a particular customer’s order, the premium is traceable and is treated as direct labour cost of that job. The basic rate for overtime hours spent on production is direct in both cases.
Show the model answer to Question 12
(a) Time-based system. Advantages: labour cost is predictable, which helps budgeting and cash flow planning; payroll is simple to run, and earnings are stable, which helps employee retention. Limitations: pay is not linked to output, so there is no incentive to raise productivity; and idle time can raise unit costs without extra output.
(b) Piecework. Merits: pay rises with output, which gives a strong incentive and raises productivity; labour becomes a variable cost, which helps cost control and budgeting. Demerits: quality may fall as workers rush; earnings vary, which may cause unrest when output is disrupted by factors outside workers’ control. (Other demerits: strain and fatigue, and unequal pay between fast and slow workers.)
(c) Guaranteed minimum wage. A minimum weekly amount paid whatever the piecework earnings. It is used to protect workers’ income from falls in output caused by circumstances outside their control, such as machine breakdowns or material shortages, while keeping the incentive to produce more.
(d) Pay calculations.
- 460 units: 200 × ₦60 = ₦12,000
- 200 × ₦75 = ₦15,000
- 60 × ₦90 = ₦5,400.
- Total = ₦32,400, which exceeds the minimum.
- 150 units: 150 × ₦60 = ₦9,000, which is below the guaranteed minimum, so the worker is paid ₦15,000.
(e) Individual and group schemes. An individual scheme rewards each employee for personal output or quality. A traceable bonus is direct labour cost, forming part of prime cost, and otherwise indirect. A group scheme rewards a team or department for collective results, which encourages cooperation. Where the bonus cannot be traced to a cost unit, it is an indirect labour cost absorbed in production overhead.
Show the model answer to Question 13
(a) Calculations.
- Current: 1,200 hours × ₦800 = ₦960,000
- cost per unit.
₦960,000 ÷ 1,500 = ₦640. - Scheme (i): hours 1,200; rate = ₦800 × 1.05 = ₦840; cost = 1,200 × ₦840 = ₦1,008,000; units = 1,500 × 1.10 = 1,650; cost per unit = ₦1,008,000 ÷ 1,650 = ₦610.91.
- Scheme (ii): hours = 1,200 × 0.90 = 1,080; rate ₦840; cost = 1,080 × ₦840 = ₦907,200; units = 1,500; cost per unit = ₦907,200 ÷ 1,500 = ₦604.80.
(b) The company would prefer scheme (ii), which gives the lowest cost per unit (₦604.80) and also the lowest total labour cost. The employees would prefer scheme (i), which pays them more in total (₦1,008,000 against ₦907,200).
Pathfinder on Labour costs, recording and remuneration
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Part (a) asks for four remuneration methods explained (4 marks). Part (b) asks for three advantages and two limitations of two chosen methods (10 marks). Part (c) on cost control and cost reduction belongs to a later topic.
Revise first: Remuneration methods
Names the two main labour remuneration methods, then asks for a 15-mark computation of the total remuneration of workers using time rate and piecework data.
Revise first: Remuneration methods
From the previous syllabus. Asks which case is NOT idle time, testing the definition of idle time.
Revise first: Direct and indirect labour
From the previous syllabus. Asks which item is NOT an advantage of a group incentive scheme.
Revise first: Remuneration methods
From the previous syllabus. Asks which item is not part of bonus incentive schemes of labour remuneration.
Revise first: Remuneration methods
Source: ICAN Pathfinder, Management Accounting. Diets covered: November Diet, 2025, November Diet, 2023, November Diet, 2021, November Diet, 2020 and May Diet, 2019 (earlier ones from the previous syllabus). May Diet, 2025 and November Diet, 2024 are not covered here.
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