Labor Cost

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Labor accounting assumes importance, as it is the second major item of cost of production. Like material, cost of labor also should be controlled for reducing cost of production and improving the effectiveness. The total amount of wages and salaries paid by a company to its employees is called Payroll.


A list of a company’s employees and the amount of money they are to be paid is called payroll. Payroll expense consists of:

  • Labor cost (Direct and indirect)
  • Administrative staff expenses (Fixed and variable)
  • Selling and distribution staff expenses (Fixed and variable)
  • Labor related cost (Commission, Overtime pay, bonus pay, shift allowances, and other benefits)


Employee Pay

Financial compensation paid to an employee by an employer for work done. Amount of money paid to an employee by an employer in return for work performed. Pay has two parts:

Gross Pay

Net Pay


Gross Pay or Employer’s Payment

The amount of pay to which an employee is entitled may be earned in a variety of different ways. These include:

1. Basic pay, such as:

  • Wages paid according to the number of hours worked
  • Wages paid according to the output of the employee
  • Salaries, for salaried staff


2. Allowances, such as:

  • House rent
  • Compensatory allowance
  • Medical allowance etc.


3. Bonuses and commission, such as:

  • Bonuses paid under bonus schemes, based on productivity, or profitability
  • Commission paid, normally based on sales


4. Other pay, such as:

  • Overtime pay, for extra hours worked by the employee
  • Shift pay, to compensate for unsocial hours


Net Pay or Take Home Pay

Net pay is equal to Gross pay minus Total Deductions. Deductions are two type i.e.

Statutory Deductions

Non-Statutory Deductions

Statutory deductions are deductions from pay that are made by state or law. In our country income tax is taken away from gross pay and paid to Income Tax Department. Non-statutory deductions are voluntary deductions from pay that the employee chooses to make Examples of these are:

  • Contributions by the employee to a pension scheme
  • Any advance taken by employee
  • Insurance etc.

Example 1:

The following figures have been extracted from a trader’s records in respect of salaries for July.

Basic Pay             Rs. 16,300

Income tax                 1,600

Employees’ pension contributions   700

Employer’s pension contributions   700

House Rent                         3,500

Medical Allowance            2,200

Insurance                             400

Car Advance Deduction      1,800

Compensatory Allowance      800

Other Allowances                    3,000


Requirement (A): What is the total amount the trader will have to pay?



Gross Pay = Basic Pay + House Rent + Medical Allowance + Compensatory Allowance + Other Allowances

Gross Pay = 16,300 + 3,500 + 2,200 + 800 + 3000

Gross Pay = Rs. 25,800


Requirement (B): What is the net pay received by employee?

Net Pay = Gross Pay – Income tax – Employees’ pension contributions

Net Pay = 25,800 – 1,600 – 700

Net Pay = Rs. 23,500


>> Practice Multi-choice Question with Answers: Labor Costing MCQs


Video Lecture: Costing Concepts in Urdu & Hindi-Workbook Practice


Click Here To Download Workbook Used in Video

Click Here To Download Workbook Used in Video


Payroll Entries

There are three entries have been passed in this regard:

  • Payroll Preparation
  • Payroll Distribution
  • Payroll Payment


Example 2:

Prepare journal entries to record payroll preparation, distribution and payment as on June 30th, 2011:


Direct Labor                                         Rs. 15,000

Indirect Labor                                            10,000

Sales Salaries                                               7,000

Administrative Salaries                            8,000

Total                                                        Rs. 40,000



Income tax                                           Rs. 4,000

Group insurance                                        1,000



Solution (a) Payroll Preparation

payroll preparation journal entry


Solution (b) Payroll Distribution

payroll distribution journal entry


Solution (c) Payroll Payment

journal entry payroll payment


>> Practice Labor Costing Quiz 1.

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Ramchandran, N., & Kakani, R. K. (2007). Financial Accounting for Management. (2nd, Ed.) New Delhi: Tata McGraw Hill.

Sehgal, A., & Sehgal, D. (n.d.). Advanced Accountancy (Vol. I & II). New Delhi: Taxmann Publication Pvt. Ltd.

Shukla, M. C., Grewal, T. S., & Gupta, S. C. (2008). Advanced Accountancy (Vol. I & II). New Delhi: S Chand & Co.

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2012). Accounting Principles (10th ed.). Hoboken: John Wiley & Sons, Inc.

Williams, M., & Bettner, H. (1999). Accounting (The basic for business decisions). (11th, Ed.) USA: Irwin McGraw- Hill.



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