Direct Labor Cost
Direct Labor Cost – Before We Get Into This Topic, Let’s Learn Some Basics Of This Topic
What is Direct Labor?
Direct labor refers to the wages and salaries provided to workers who are directly involved in the production of a product or the provision of a service. The work done must be connected to the task at hand. Direct labor is the work done by employees that give services directly to clients, such as auditors, lawyers, and consultants, for a company that delivers services to its clients.
The wages paid are deemed indirect if the work performed cannot be linked to a single employee. Because direct labor costs can account for a considerable amount of a project’s total cost, they must be included when tracking the entire cost.
The salaries and earnings provided to workers who can be directly connected to specific products or services are referred to as direct labor.
It covers regular working hours, overtime hours done, payroll taxes, unemployment tax, Medicare, and unemployment insurance, among other things.
In the manufacturing process, direct labor might be allocated to overhead.
How to Measure Direct Labor?
The cost of direct labor includes both regular working hours and overtime hours are done. It also covers payroll taxes and expenses like social security, Medicare, unemployment insurance, and worker’s compensation. Companies should also account for contributions to pension plans and health-care-related expenses. Employee training and development fees incurred during employment may be included by some companies.
Every cost item involved in keeping and hiring staff must be included when determining direct labor costs. Employee retention costs, such as payroll tax payments, insurance premiums, and benefits expenditures, must be included in addition to what the company pays its employees.
Most businesses create a standard rate per hour as an estimate of what they expect direct labor costs to be in normal circumstances. Assume that the direct labor cost per hour for building baby car seats is $10 and that the corporation anticipates each car seat to take 0.5 hours to assemble. The normal direct labour cost will be $5,000 ($10 x 0.5 x 1,000) if the company produces 1,000 items.
Using Direct Cost to Allocate Overheads
Companies may utilize direct labor as a cost driver to allocate overhead expenses to the production process, according to GAAP guidelines. Overhead costs are costs that are not directly related to a certain ultimate product. However, such expenditures are a necessary part of the manufacturing process and must be factored into the ultimate price of the product. A cost driver is used to distribute costs to the end product.
The cost driver is easiest to quantify by dividing total overhead costs by direct labor costs. The number of employees required to make a certain product or the number of employee hours used per unit of production are both examples of direct labor. For example, if the overhead cost to direct labor hour ratio is $35 per hour, the corporation would allocate $35 of overhead costs to the production output.
How to Calculate Direct Labor Cost per Unit
The amount of direct labor cost incurred is determined by how efficiently the workers created final goods. Typically, businesses develop a standard direct labor cost against which their actual direct labor costs can be compared. Here’s a way to figure out how much direct labor costs per unit of output:
1. Calculate the direct labor hourly rate
To begin, determine the direct labor hourly rate, which includes fringe benefits, hourly pay rate, and employee payroll taxes. The hourly rate is calculated by multiplying the number of fringe benefits and payroll taxes by the number of hours worked during the payroll period.
Assume that employees are paid $13 per hour and work 40 hours per week. In addition, they receive $100 in fringe benefits and $50 in payroll taxes. Calculate the total of benefits and taxes (100+50) and divide by 40 to get 3.75. The $3.75 is added to the $13 to arrive at a $16.75 hourly rate.
2. Calculate the direct labor hours
The number of direct labor hours required to create one unit of a product is referred to as direct labor hours. The figure is calculated by multiplying the total number of finished goods by the total number of direct labor hours required to make them. For example, if it takes 100 hours to make 1,000 things, it will take one hour to make ten products and 0.1 hours to make one unit.
3. Calculate the labor cost per unit
Multiplying the direct labor hourly rate by the time required to complete one unit of a product yields the labor cost per unit. For example, if the hourly rate is $16.75 and one unit of a product takes 0.1 hours to make, the direct labor cost per unit is $1.68 ($16.75 x 0.1).
4. Calculate the variance between the standard and actual labor cost
The variance is calculated by subtracting the standard direct labor cost per unit from the actual direct labor cost per unit. If the actual direct labor cost per unit is higher than the predicted direct labor cost per unit, the cost of producing one unit of a product is greater than planned, making the cost unfavorable to the business. It is more cost-effective to produce one unit of a product if the real direct labor cost is lower than the standard direct labor rate.
Direct Labor Cost Method
Materials and labor costs are incurred by all businesses, large and small, for all items and services produced. It’s critical to keep labor costs under control if you want to hit your profit targets. Effective direct labor cost management begins with precise cost tracking and the use of that data to identify and correct problems that result in excessive spending or inefficiency.
Work expenses connected to the actual manufacture of a good are referred to as direct labor costs. The cost of labor necessary to perform a service is referred to as direct labor cost in the service industry. Employees that are not involved in the production process, such as administrative and office personnel, are not considered direct labor. Personnel who work on the shop floor and are responsible for maintaining or putting up equipment are only included.
You must include all costs, not just pay when calculating direct labor cost. Employer-paid Social Security, Medicare, and unemployment taxes, as well as workers’ compensation insurance, would be included. Other factors that must be included in the overall labor cost include health insurance costs and contributions to pension programs. You may need to budget for training and workforce recruitment as well.
To analyze direct labor costs efficiently, you must first create a model or standard rate. The standard rate is an estimate of what the direct labor cost will be in normal circumstances. The predicted cost of one hour of direct labor and the number of work hours necessary to create one unit are the two main components of this model. Assume your total direct labor cost is $15 per hour, and you plan to use 0.5 hours per unit of manufacturing. The standard labor cost for a shop that produces 1,000 units each week is $7,500.
In the real world, it’s rare for actual results to match standardized models exactly. Direct labor cost analysis is useful in identifying large deviations from predicted outcomes. Rate variance and efficiency variance are the two major things to check for. When real labor expenses are higher or lower than predicted, rate variation occurs. For example, you can discover that you spent $16 per labor hour instead of the predicted $15, which is a negative difference. A deviation from the amount of labor necessary to create one unit is called efficiency variance. As a result, you would have a favorable variance if you used an average of 0.4 hours to make one unit instead of the expected 0.5 hours. It is possible to preserve and improve profitability by determining the causes of either type of volatility.