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SAN FERNANDO VALLEY STATE COLLEGE DETERMINATION OF EMPLOYEE COSTS,, A.THESIS SUBMITTED TO THE FACULTY OF THE DIVISION OF BUSINESS AND ECONOMICS IN CANDIDACY FOR THE DEGREE OF MASTER OF SCIENCE BUSINESS ADMINISTRATION BY BRUCE LOWELL MIKESELL NORTHRIDGE, CALIFORNIA JtmE ' ':-, ' ::. ' '.. ' ':-: TABLE OF CONTENTS Page LIST OF TABLES. iii Chapter 1 INTRODUCTION Significance of Employee Costs Thesis ObJective IV. DETERMINATION PROBLEMS Definition Problem Accounting Problem Method of Compilation Probl~ POLICIES FOR DETERMINATION OF EMPLOYEE COSTS Policy for Definition of Terms Policy for Accounting Policy for Method of Compilation CONCLUSION ~othesis Substantiation Potential Knowledge Potential Utilization BIBLIOGRAPHY ii Table LIST OF TABLES Page 1. Employee Costs Included in Selected Surveys Z7 z. Bases for Employee Costs in Selected Surveys Total Employee Costs by Category of Cost and Employee 54 iii CHAPTER 1 INTRODUCTION Significance of Employee Costs Employee costs have been a significant factor in the national economy for many years. To the employee, employee costs have represented to a considerable extent his personal income. To the employer, employee costs have affected his cost of operation and consequently the profitability of his firm. To the national economy, employee costs and their distribution in personal income have had a fundamental effect on personal consumption expenditures in the economy. Historical Growth Total compensation of employees in the national economy increased from 4Z.9 billion dollars in 1936 to Z41.4 billion dollars in The increase in total,compensation of employees included the growth of the supplements to wages and salaries from 1 billion dollars in 1936 to 14.1 billion dollars in Because the total compensation of employees included payments such as tips, compensation for injuries, pay of the military reserve and other minor items of labor income, these payments were not restricted to the employee 1u.s., Department of Commerce, Business Statistics 1957 (Washington: Government Printing Office, 1957), P 2. 1 costs of employers. However, the aggregate income figures reflected significant increases which indicated an increase in employee costs; e.g., wages and salaries for private industry increased from 34.1 billion dollars to billion dollars during the same period~ 2 On an individual employee basis, the manufacturing production worker payroll index which represents the production worker average weekly payroll increased from 27.2 in 1936 to in 1956~ Although the index did not reflect total employee costs due to the exclusion of cash payments for vacations not taken and several other cost factors, the index indicated that the average weekly payroll cost per employee increased significantly from 1936 to In addition, the average hourly gross earnings in all manufacturing increased from $0.556 in 1936 to $1.98 in The growth in employee costs has been accompanied by a material change in composition of the employee costs. Although somewhat elementary, employee costs have not been exclusively the dollars per hour which are paid an employee. Employee costs have been increased and complicated in definition by the inclusion of a multitude of legal or voluntary payments on behalf of the employee by the employer. These additional costs, often termed employee or fringe benefits, have materially increased during the past twenty to thirty years. Typical costs attributable to statutory requirements are illustrated by the employer payments for social security, 2 Ibld. - 3.!J?..!!!. ' P Ibid., P 74. 3 workmen's compensation, and unemployment compensation. Social security costs of the employer have increased from $30 per employee per year in 1937 to $144 per employee per year in State workmen's compensation programs, the first of which was passed in 1910, is probably one of the oldest forms of statutory employee costs and currently costs employers approximately $32 per year per employee.6 California State Unemployment Compensation Insurance, in effect since January 1, 1936, was similar to the Federal Railroad Unemployment Insurance Act of 1935 and resulted in employer taxes of $9,225,760 in 1936 which subsequently increased to $154,276,724 in Typical of the benefit costs which have not been legally required and have benefited employees are the multitude of employer supported insurance programs, supplemental unemployment benefit programs, and a variety of employee benefits such as discounts or subsidizations for goods, services, meals, and lodging. Probably, the most significant cost it~ of the previously cited benefits is the group insurance benefits. The Institute of Life Insurance reported that group life insurance in force for 1958 amounted to s~lt Keeps Costing More For Your Old Age Security, U.S.News and World Report,Oecember 21, 1959, P 93. 6senate of the State of California, Employee and Teacher Benefit Programs (Sacramento: 1958), p Los Angeles Examiner, August 9, 1959. billion dollars which was nearly four times the total or ten years previous.a The introduction and growth or employee or fringe benefits have had a profound effect on the employee cost structure, if a recent national study of fringe benefits is a reliable indication. A biennial survey of 102 national firms from 1947 through 1957 indicated the following increases in fringe payments: (1) from 15.0 to Z3.7 per cent or payroll a rise or 58 per cent in the ten year period; (Z) from 20.6 to 55.8 cents per payroll hour - a rise of approximately 170 per cent in the ten year period; (3) and from $420 to $1,150 per year per employee -a rise or 174 per cent in the ten year period. 9 Impact on Economic Decisions Employee costs imply the establishment or an economic value for labor resources or input - one or the three major classes of national economic resources which include labor, land, and capital.lo The growth of labor input costs has required a review of economic decisions by the individuals and organizations within the economy. Individual firms have been required to quanitatively evaluate the proportions or input 8 1nstitute of Life Insurance, Life Insurance Fact Book 1959 (New York: 1959), p chamber of Commerce or the United States, Fringe Benefits 1957 (Washington: 1958), p. ZB. l~arold Barger and Horace Taylor, The American Economy Operation (New York: Harcourt, Brace and Co., 1949), P 39. 5 in order to achieve the most profitable cost of operation; i.e., economic survival forces firms to select the least costly input such as machine processes in place of manual ones.ll Labor unions view the increase in labor input costs as the attainment of higher wages - one of the primary objects of trade unionism.l2 The complexities of the economic decisions necessitated by increases in employee costs have been illustrated by the advent of supplemental unemployment benefits. The advent of SUB plans has required several unions to demand SUB plans in collective bargaining and has confronted many employers with significant potential increases in labor input costs.l3 Employees have been confronted with new consumption decisions as a result of the increase in labor input costs which were transformed into disposable income which the employee utilized for consumption. To the extent that the increased labor costs have resulted in increase prices or inflation,l4 the public and groups which have suffered a reduction in real income have been required to adjust the amount demanded of goods and services for which 11 Ibid. P E. Wight Bakke and Clark Kerr, Unions, Manalement and The Public (New York: Harcourt, Brace and Co., 1949, p. 3o, citing Samuel Gompers, The Philosophy of Trade Unionism. 13Jules Backman, High Costs of Liberalizing SUB Plans , Harvard Business Review,Volume 34, No. 6, Nov - Dec ~ 69 14Neil H. Jacoby, The Threat of Inflation , Harvard Business Review, Volume 35, No. 3, May - June 1957 P 15. 6 prices were increased. The impact of increased labor input costs on economic decisions has required reviews of pricing decisions by firms, collective bargaining demand decisions by the unions., and consumption expenditure decisions by employees and the public. Thesis Objective Hypothesis The thesis presents the hypothesis that present methods of determining employee costs have not accurately represented labor input costs. The hypothesis assumes that employee costs are a synonym for labor input costs which from the viewpoint of the economist should reflect the expenditures by the employer for labor, one of the three major classes of economic resources.15 Clarification of Problems The question of accuracy in determination of employee costs has resulted from problems created by the lack of a uniform, complete definition of employee costs, the inadequacy of existing accounting systems, and the unreliability of current methods for compilation of employee costs Barger, p u. s., Bureau of Labor Statistics, Problems in Measurement of Ex enditures on Selected Items The first problem creates the second problem because an adequate accounting system cannot be established without an adequate definition of employee costs. Each of the three problems is separately considered in Chapter II. Resolution of Problems Although the clarification and subsequent evaluation of the problems might suffice in answer to the hypothesis. Chapter Ill of the thesis is devoted to policy recommendations for resolution of the problems. The thesis proposes an input oriented definition of employee costs including the basic cost increments, a recommendation for implementation of the employee cost definitions within cost accounting systems, and an outline of possible techniques for compilation of employee costs within a firm, industry, and geographic region. Conclusion The final chapter in the thesis summarizes the substantiation for the hypothesis. In addition, the knowledge whic could be garnered from adoption of the policy recommendations and the potential utilization of this knowledge are presented. 7 CHAPTER II DETERMINATION PROBLEMS Definition Problem Employee costs have meant many things to many people. Economists, managers, unions, and others have defined employee and employee costs in different ways. The term, employee, occasionally has been restricted to individuals who are employed for the performance of productive effort rather than the individuals who are employed for managerial direction. Many terms which by themselves have been inferred to be employee costs have been developed. ~xamples of common terms for employee costs include income, wages(' and salaries, gross payroll, employee benefits, fringe~ beneflts,,and many other variations. Also, the definition,of these terms has varied among individuals, firms, and,. ind':'stries. The definition complexity of employee costs.l)as required separat-e consideration of the employee and costs' terms. Employee Definition The definition of employee has been subjected to many interpretations. The term, employee, has been applied occasionally to anyone who is employed. On the other hand, employee has been restricted to individuals within a finite 8 group who are employed by a specific entity. Economic definition Economists have referred to employees, the term for labor in this thesis, as individuals who are employed for compensation by some individual or organization.l This broad definition has included such diverse categories as domestic servants and corporation presidents, and has not been restricted by considerations of the nature of the occupation, the amount of compensation, or the characteristics of the employer. Managerial definition The executive, manager, or supervisor has often tended to regard the personnel who are responsible to him as employees. The inclination of managerial personnel to separate themselves from the employee category has been '.. nurtured and represented by the publications of many authors who have attempted to establish arid accentuate distinctions between. executives and employees, supervisors and workers, and wages and salarles w. F. Woytinsky and Associates, Emplo* ent and Wa~es in the United States (New York: The Twentleth :enury Fund,953), P Leland Hazard, What Economists Don't Know About Wages, Harvard Business Review, Vol. 35, No. 1 (Jan.-Feb.l957),p.48. 10 Union definition Formal definition of an employee by union organizations has often been restricted to the individuals within the bargaining unit of the company.3 Historically, unions have considered employees or workers as a finite group within the enterprise situation; i.e., the unions have regarded employers as a separate group within a firm.4 Accounting definition Accounting principles generally have classified labor as direct, indirect, administration and distribution. Direct labor has usually referred to workers who directly perform productive effort.5 Indirect labor has generally consisted of employees who dndirectly support the performance of productive effort. 6 Although immediate supervisory personnel usually have been included, indirect labor has often excluded executives and salesmen who have been reflected ln administration and distribution categories respectively. ~ Agreement Between North American Aviation ahd the United Automobile Aircraft and Agricultural Implement Workers of America (Los Angeles; North American Aviation, May 19,1958) p.8. 4E. Wight Bakke and Clark Kerr, Unions, Manaaement and the Public (New York: Harcourt, Brace and Co., 194 ), p. 1. 5Glenn A. Welsch, Budgeting: Profit-Planninl and Control (Englewood Cliffs, N.J.: Prentice-Hall Inc.,957),p Ibid. 11 Management has generally limited the uses of accounting to determination of period profit, budgetary planning, cost control and product pricing. 7 Some theoreticians in labor cost accounting have proposed the inclusion of accounting for all compensation for s~rvices by employees in the objectives of payroll accounting.e However, the general cost accounting definition has tended to fragmentize labor in order to satisfy the requirements for product costing and responsibility accounting; the definition of employees in an inclusive group has been recommended, although not generally accepted, by accountants who apparently recognize the potentia! value for management in input costing even though management has obviously limited the accounting objectives to financial, cost control, and product cost accounting. Classification of labor for costing labor input has not been required by management; consequently, cost accounting has been devoted to costing production and re$ponsibility accounting which have promulgated and justified the establishment of the current accounting employee definitions.9 Government definition Innumerable varieties of employee definitions have been developed from the statutes and the administrative 7 wyman P. Fiske and John A. Beckett, Industrial Accountant's Handbook (New York: Prentice-Hall, Inc.,l954),p.4. 8 Ibid., P welsch, P Z9. 12 interpretations of the federal, state, and municipal government units. Statutes which have defined the term, employee, have been exemplified by the social security acts, unemployment compensation acts, workmens' compensation acts, state sickness and accident benefit acts, fair labor standards act, and personal Income tax acts. Basically, the statutes have not attempted to formulate the broad theoretical definition of employees; i.e., the statutes have individually endeavored to describe employees in sue~ a manner as to satisfy the specific intent of each particular statute. Therefore, an individual who has been considered an employee within the meaning of one act, might not have been considered an employee within another act. A problem in employee definition often results from an attempt to classify employees by the definition of a specific statute. Surv!Y definition Dissimilar definitions of employees have been adopted by several notable organizations who have conducted surveys of supplementary employee compensation. The Bureau of Labor Statistics in a survey of manufacturing establishments classified employees as production and related workers which coincided with the definition regularly used by the Bureau and which Included generally all employees directly performing production effort and excluded all employees engaged in office, supervisory, executive, temporary construction, 13 mi 11 tary service, and pens ion categor ies.lo A study for the Senate of the State of California in a survey of private industry employee benefits defined employees as the personnel within the non-exempt hourly rated and salaried group within a company. 1 1 ln this instance, the definition by the State of California was based on the Fair Labor Standards Act. The Chamber of Commerce of the United States in a survey of fringe benefits limited employees to hourly rated personnel and salaried personnel who are paid on an hourly basis. 1 2 Althouqh the variations in definitions might have appeared unimportant, comparisons of the foregoing definitions have presented several incongruities. For example, the Chamber of Commerce of the United States has limited the employee group to personnel paid on an hourly basis whereas the United States Bureau of Labor Statistics has included working foremen. Therefore, comparisons between the survey reports have equated different employee groups. Summation The comprehensive employee definition which has been utilized in economics naturally coincides with the definition of the hypothesis because the definition of hypothesis llsenate of the state of California, Emplotee and Teacher Benefit Programs (Sacramento: 1958), p.13. l2chamber of Commerce of the United States, Fringe Benefits 1957 (Washington: 195tf), p. 36. 14 has been formula ted from the economic definition has classified employees as the individuals who are employed for compensation by some individual or organization. However, the managerial, union, accounting, government, and survey employee definitions generally have not corresponded with either each other or the comprehensive economic definition. A noteworthy exception to the lack of comprehensiveness has occurred in the Office of Business Economics of the United States Department of Commerce who have defined employees as persons in an employee status receiving compensation for their work.l3 Determination of employee costs on the basis of the managerial, union, accounting, government, or survey definitions would not represent the cost for all employees in a firm, industry or geographical region regardless of the completeness of the cost definitions. In addition, any comparisons of employee costs between studies which were based on dissimilar employee definitions would be equating different groups of employees. Cost Definitions A multitude of qualitative definitions has been developed for the determination of employee costs. Qualitative definitions have varied from the simple, general statement to the complex, specific itemization. The 1 3u. s., Department of Commerce, Business Statistics 1957 {Washington: Government Printing Office, 1957), p. 197. 15 utilization of simple, general statements has occurred as a result of the potential problems which might have been created in quantitative compilation of specific, complex qualitative itemizations.l4 Terms which have been inferred or stated as employee costs have ranged from income equivalents to employee costs including fringe or employee benefits. Income equivalent. Several income definitions have received wide acceptance as measurements of employee costs and have been justified in some instances by deductive logic; e.g., because gross wages are a cost to the employer, gross wages are the employee costs. However, the previous example has erred by inferring that gross wages were the only employee costs. Similarly, several income definitions have reflected the earnings of either too many or too few categories to equate employee income to empl
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