What is Overtime in Cost Accounting

What is overtime in cost accounting

Everyone must be familiar with the word ‚Äėovertime‚Äô. Either they have heard this word in their daily lifestyle or their professional lifestyle. Basically, overtime is the extra hours anyone spends to complete the targeted work or incomplete work. It is beyond the normal working hours. Consider a company getting a bulk of immediate orders that has to be completed within the targeted time.

The company can not complete the order within the targeted time if its employees are working within their normal work period. The company will require its employees to work overtime, so the orders can be finished within the given timeline. In such scenarios, the company pays the employees good compensation for working overtime. In this article, we will learn more about what is overtime in cost accounting, its advantages, disadvantages, and much more. 

What is overtime in Cost accounting 

According to the Indian factory act, if an employee is working after his/her normal work time then the extra work hour is considered as overtime. Indian factory act calls a shift of 9 hours a normal work period. The law of this act always favors the employees/workers of a company.

It rules that if an employee is working more than 9 hours a day or 48 hours a week, it is his/her overtime duty. And for this overtime work, the company has to compensate with double wages to the employee. This act has made a practice of paying more wages during overtime shifts. The amount paid for the overtime shift is known as Overtime Premium. A factory pays its workers for overtime according to the laws of the Indian factory act. A company can also make a mutual agreement between its workers’ unions for the overtime wages. 

Sometimes many auditors raise concerns about overtime premiums. They do not consider it reasonable to charge some extra wages for work that has been done in overtime. However, they suggest a provision to increase the wages of employees that can compensate for their overtime works.

They consider this method suitable when overtime is needed to fulfill a rush or immediate order. For example, A company gets a large rush order and has to complete it within a specific time. Neither the company has much capacity for workers nor it can afford to hire new workers and train them. So it requires the workers to do overtime to complete this order. In such conditions, auditors consider it proper to charge some extra wages for the overtime. In terms of overtime, the company has two options of policies to implement: 

  1. Either the company hire more workers and allow few overtime shifts
  2. Or the company hire fewer workers and encourage them to do more overtime shifts 

The management team wisely chooses a policy for the company after lots of cost-benefit analyses. 

 Rates and calculations of overtime in cost accounting

Earlier, overtime payment was a difficult task for the accountants of a company. They used to consider overtime in cost accounting a complex system. There were so many factors that made it a difficult task. After the implementation of its rates and calculations, it has become a simple equation. 

Indian factory act determines 9 hours a day or 48 hours a week, a standard work time. And the rates for overtime in cost accounting should be maintained doubled as compared to the normal wage. Different countries have different standard work times and overtime rates.

It is 44 hours a week in Canada, 40 hours a week in the United States, 38 hours in the UK, and just a mere 35 hours a week in France. Many countries treat overtime payment as 1.5 times the worker’s normal wage. But in California, the workers are entitled to double-time payment for their overtime shifts. If an employee is working for 7 days regularly in California, he/she will get a double payment after the first 8 hours on the 7th day. 

Overtime premium consists of two elements: overtime payment in addition to the normal wage of the worker. Therefore, it is often referred to as multiple rate wages. Because a worker gets two different wage rates for the same work. For example, a worker gets 200 rupees a day in his/her normal work time, but the same worker will get 300 rupees a day in his/her overtime shifts. 

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Now we are familiar with what is overtime in cost accounting, its rates, and calculations. Let us have a look at the reasons that cause frequent overtime in a company. Sometimes these reasons also affect the account sheet of a company. 

Reasons for overtime 

Factory act has made certain rules and regulations regarding overtime shifts. It states that the company should properly determine whether its workers are eligible for overtime shifts. The act has made certain criteria required to meet for overtime. But the companies often violate their rules and regulations. Many companies have made a policy of hiring few employees and encouraging them more for overtime. 

Sometimes the company requires overtime for its benefits and achievements. From raising production to machine failure, many reasons cause overtime. But some of the prominent reasons are mentioned below: 

Shortage of labor: One of the most prominent reasons that cause overtime is the lack of sufficient employees. Shortage of labor occurs due to two reasons: (a) workers are on a leave for some time due to illness, vacation, or for other reasons. (b) the company has hired insufficient workers and tends to implement the policy of overtime encouragement. 

Survey reveals that in most cases the company did not hire enough employees. But the survey also claims that most companies can not afford more workers than they have. They can not avail a full-time job for the workers when they require them in some seasonal peaks only. So they consider overtime shifts a comfortable option. Hiring new workers and training them is far more complex than mandatory overtime. In some companies, it is mandatory for workers to work overtime, when required. 

Seasonal orders: Another common reason for most of the companies requiring overtime is some rush or special order in seasonal peak time. Suppose a company has enough workers to finish the work in their normal working hours. But suddenly it gets an immediate order with a certain deadline.

The order is big enough that neither the company wants to lose it nor can it complete the work within the given deadline. In such situations, the company can not hire new employees because hiring and training processes take a lot of time. And the company requires more workers till the seasonal peak.

So it requires the employees to work beyond their normal work time. And the company is happily willing to compensate for the overtime. Such situations happen more often to a globalized company because they rely more on the different regions. 

Production expansion: Employees of a company often work overtime during holidays if a company is expanding its production capacity. During the expansion, the company does not want to focus on hiring new people. Rather it insists on preparing production schedules.

In such situations, a company gives the workers an opportunity to earn more. Most workers like the idea of overtime because they can earn more during overtime works. But sometimes it ends up being their limitation. If a company is able to expand its production during overtime, then it should regard overtime wages as an overhead cost. 

Unfavorable Acts: From natural disasters to strikes and accidents, everything that affects the production of a company is regarded as unfavorable acts. Market slow down and financial problems are the main elements of unfavorable acts.

The production efficiency of a company decreases drastically in such situations. Companies face many problems during such situations and increase production as soon as it ends. This whole situation results in overtime shifts. The accountant should transfer such overtime wages into a profit & loss account. The firm should consider such expenses as an abnormal loss. 

Advantages of overtime 

Sometimes overtime in cost accounting is a healthy sign for the company, as it shows its production efficiency. But if a company requires overtime on a regular basis, then it should probably think of hiring more employees.  From a worker to a company, overtime provides both an opportunity to earn more and utilize the resources. Sometimes overtime motivates the workers even at the peak of workload. 

Following are some of the advantages of overtime:
Increases productivity immediately: One of the major benefits of overtime is it increases production instantly. Employees work for long hours to increase the production level. Generally, it happens during the seasonal peak of time. The company allows all its workers to work more overtime. Thus the company is able to complete the orders at a faster rate.

If the policy of overtime is enacted properly, it becomes a normal feature of overtime to increase productivity. The management team can wisely maintain this feature for a long time. It also increases the reputation of a company. Because overtime finishes the order on time by increasing the production fastly.

Increases profitability: It depends upon the situation that a company will earn or lose from overtime shifts. If a company requires overtime just because of the unfinished work, overtime might disbenefit the company. But if a company requires overtime because of production expansion or rush orders, then it surely benefits the company. Such orders are very special and sometimes it increases the goodwill of a company. Proper utilization of overtime increases production, which automatically generates more revenue. 

Benefits to the employees: Most of the employees are always ready to work overtime. It adds some extra money to their budget. Workers can utilize their holidays by working overtime. Companies pay them double wages for working overtime shifts. In addition to this, over time also increases the chances of promotion.

Because it earns the reputation of being a hard worker and a team player. If more employees are willing to work overtime very often, then the company will avoid hiring more employees. It definitely leads to more workload but it also increases the earnings of workers. A company always avails these perks to motivate the employees. 

Utilizes time and resources: During the normal work time, wastages of raw materials are high. Some raw materials also lose their quality due to long storage. Due to the heavy workload workers can not utilize the spoiled material properly. But over time allows proper utilization of raw materials. Also, it does not require any extra time for machinery work. Overtime allows checking the proper functioning of machines and procedures. Along with heavy production, the company utilizes over time for, different purposes. 

Disadvantages of overtime 

Sometimes overtime affects both the employees and the company. Workers who work overtime very often may affect their mental and physical health. In the case of a company, overtime shows its production inefficiency. Very often over time raises questions about a company’s time management. Following are some of the disadvantages of overtime: 

It is expensive: Overtime payment is an additional wage over normal wages given to the workers. Companies have to pay the workers doubled wages for the overtime work. In addition to this, companies have to pay extra electricity costs, supervision costs, and machinery costs.

Thus overtime works require more indirect expenses, making overtime a costly factor. It requires more cost if the work is done within the overtime period. Cost factor majorly affects the unfinished works requiring overtime. But if a company is allowing over time due to heavy orders then it should treat the overtime wages as production cost. 

Affects productivity: Overtime surely increases the production of a company but it can decrease the production in normal working hours. It can decrease a worker’s efficiency and hence can affect output productivity. Sometimes the workers slow down their working efficiency in normal working hours. They do so because they can earn more by finishing their work in overtime working period. Employees may depend on overtime to finish a particular task. Sometimes it raises disputes if the overtime is not properly distributed among the workers. 

Affects worker’s health: Generally, overtime comes at late hours or on holidays when the workers are tired. They can not work efficiently in such crucial conditions. But because of some extra wages, workers work overtime and it leads to their bad health. WHO study claims that lakhs of workers are dying every year from just doing excess overtime. Regular late hour working leads to ischemic heart diseases to the workers. Health issues ultimately lead to the absence of workers in the company. It also results in decreasing the performance of workers.¬†

Other limitations: Besides all these disadvantages, there are some other limitations of overtime. It may lead to the failure of machines due to their continuous operation. Researchers claim that overtime increases the risk of injury and errors. It also claims that workers lose the alertness level due to the lack of proper rest. Overtime work should be done under proper precautions. Sometimes it also affects the quality of production. 

Ways to control overtime

A company should understand and improve the workload of its workers. It is slightly difficult to avoid overtime completely. But the management can reduce overtime and its effects also. 

Following are some of the ways to control overtime: 

  1. Management should utilize the normal working hour. They should maintain efficient productivity during normal working hours. They should finish the work within normal working hours and should avoid overtime. 
  2. The Head of the department should authorize the overtime work. They should properly ensure the necessity of overtime. Without their concern, no overtime work should be allotted. 
  3. Management should properly distribute overtime works among workers. They should also check their eligibility. They should not allow a worker very often overtime work. It might result in affecting the workers’ health. 
  4. The supervisors should ensure that workers are not misusing the overtime provided to them. They should avoid allotting frequent overtime. 
  5. The supervisor should derive the productivity efficiency of a department during normal working hours. And then they should compare the efficiency during overtime working hours. 
  6. Each department should maintain overtime wages in cost accounting. If a department requires overtime on a regular basis the company should treat it differently. Either they should hire new employees for the department or they should consider the overtime wages as production cost. 
  7. If a department requires overtime due to the lack of resources, the company should take correct steps towards it. For better productivity results departmental heads should arrange these inputs immediately. Like: Failure of machines, lack of sufficient equipment, etc. 

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