Companies depend on many elements that are interconnected and work together to function properly. Some of these elements may shift and change depending on the nature of the business.
For this reason, it is very important to identify which parts of your business vary and track these changes so that you can budget and plan effectively.
In this article, we will discuss what direct labor is and how to calculate it, plus share examples of determining direct labor.
Contents
2 How to calculate direct labor costs?
3 Examples of direct labor cases
4 Differences between direct and indirect labor
What is direct labor?
Direct labor refers to work performed by employees who contribute directly to producing products or providing services.
Some companies may categorize direct labor based on specific products, cost centers or work orders. For example, a residential painting company may set its direct labor costs based on each house they are painting.
The nature of the organization determines the type of employee wages that are considered direct labor costs. Direct labor in the manufacturing business includes workers who work directly in the production sector, including:
- Assembly line operator
- Machine operator
- Painter
- Carpenter
- Delivery truck driver
In service-based businesses, direct labor refers to employees who provide services, such as:
- Lawyer
- Consultant
- massage therapist
- Counselor
- Accountant
Sometimes, service providers have to track how much time they spend on each particular service, such as data acquisition and client meetings.
This is often the case in industries that use billable hours to bill clients, such as financial professionals and attorneys. Although divided into groups, all these billable hours are considered direct labor costs.
Meanwhile, peripheral services, such as facility maintenance and administrative roles, are considered as indirect labor.
How to calculate direct labor costs?
The following are the steps to calculate direct labor costs :
1. Identify which costs are direct labor costs
Employees must be directly involved in the production or provision of services in order to be counted as direct workers. These employees may be paid hourly or salaried.
2. Add direct labor costs
Determine the total costs for direct labor for a given time period, including:
- Employee salary
- Income tax
- Pension contribution
- The health insurance policy covered by the company
- Workers’ compensation policy
- The life insurance policy is covered by the company
- Other company benefits
2. Calculate hourly labor costs, if needed
You can calculate direct labor costs per hour by dividing the total direct labor costs for a given period of time by the number of hours worked during that period.
For example, if you determine that the total direct labor cost for an employee is 60,000,000 per year and the employee works 2,000 hours per year (40 hours a week for 50 weeks of the year), divide 60,000,000 by 2,000 to determine the employee’s direct labor costs. . per hour: 60,000,000/2,000 = 30,000 per hour.
3. Calculate labor costs for other time periods
Now that you have hourly direct labor costs, you can use them to determine daily, weekly, monthly, or quarterly direct labor costs for the employee.
For example, if an employee works 40 hours a week, the direct labor cost to the company for the week is 40 times 30,000, or 1,200,000.
Also read: How to Calculate Beginning Inventory?
Examples of direct labor cases
The following are some examples of the use of direct labor costs. The first example shows hourly direct labor costs and the second shows how to calculate direct labor costs for a quarter of the year:
Example 1
Brew Good Coffee produces and distributes whole bean coffee. The facility employs 15 employees who work on the production, packaging, and delivery of coffee bags.
The owner of Brew Good wants to calculate the direct labor cost per hour of his factory employees for the previous year.
First, the owner determines the total cost for the 15 employees by adding up wages, benefits and other contributions. The total is 750,000,000, which is the total direct labor cost for the year.
Next, the company adds up the number of hours worked by factory employees in the past year. Ten employees worked 40 hours a week for 50 weeks for a total of Rs 107.74 hours. (10 x 40 x 50 = Rs 107.74).
The remaining five employees work 35 hours a week for 48 weeks of the year for a total of 8,400 hours. (5 x 35 x 20 = IDR 8,400). This brings the number of hours worked to 20,000 plus IDR 8,400, or IDR 28,400 hours.
Finally, Brew Good can divide the total direct labor cost by the total number of hours to find their hourly direct labor cost.
Direct labor costs per hour = IDR 750,000,000 total direct labor costs / IDR 28,400 hours = IDR 26,400 per hour
Also read: Sensitivity Analysis: Definition, Benefits and Examples
Example 2
Bright Bloom is a florist in a big city. The owner wants to determine the company’s direct labor costs each quarter.
The company employs six florists who make bouquets, two traveling florists to assist with events and two delivery drivers.
The flower shop earns an annual salary of Rs 242415.75 each. The florist consultants make 188.55 Rs per hour, and the delivery driver makes 134.68 Rs per hour.
To determine direct costs for the previous quarter, the owner of Bright Blooms must determine what each employee made in that time period.
To calculate the florist’s income, divide $45,000 by four because there are four quarters in a year. The result is 11,250,000 for each florist in one quarter or Rp 67,500,000 for the six florists.
The floral designer consultants each worked 120 hours per month in the previous quarter, for a total of 360 hours per consultant. Overall, the two consultants worked 720 hours in one quarter with an income of Rs 135752.82.
Delivery drivers worked 40 hours per week during the quarter, for a total of 960 hours for both drivers. At Rs 134.68 per hour, they make Rs 129288.40.
In addition to employee salaries, the owner of Bright Blooms spends Rs 1077.40 per month on benefits and insurance for his employees. The total cost of this allowance for the quarter is Rs 1077.40 over three months, which is Rs 32322.10 per quarter per employee. With 10 employees, the cost is Rs 32322.10.
Owners can calculate direct labor costs for the quarter by adding up all of these costs:
Quarterly direct labor costs = Rs 3,63,623.63 + Rs 135752.82 + Rs 129288.40 + Rs 32322.10 = Rs 660.99
The difference between direct and indirect labor
Here are 9 differences between direct and indirect labor in a business:
1. Understanding
Direct labor is personnel who are directly involved in the manufacturing process of an entity. Meanwhile, indirect labor is all other personnel of an entity who work across departments but are not directly involved in the manufacturing process.
2. Contribution and its relation to the manufacture of the product
Direct labor jobs can be directly viewed and traced to a specific manufacturing process or specific product. For example, the efforts of employees in the packaging department are clearly reflected in the packaged products.
While the work of indirect labor cannot be seen or tracked in certain processes or products. For example, the efforts of auxiliary workers in factories such as cleaning and security officers cannot be seen directly in the products produced.
3. Work done
Direct labor generally performs all functions related exclusively to the manufacturing process. Indirect labor performs a plethora of functions that can range from administration to accounts and finance to sales and marketing and everything in between.
4. Workplace
Direct labor works on the factory or shop floor. Meanwhile, indirect labor can be used in any part of the entity’s location, be it in factories, offices, or in the field.
5. Variability
Direct labor costs are generally variable, that is, they change proportionally with changes in the level of output.
Whereas indirect labor, on the other hand, can be variable, semi-variable or fixed. For example, the salary of a security guard can remain the same regardless of whether there is an increase or decrease in the level of output.
6. Cost allocation
Direct labor costs are allocated directly to manufacturing units based on hours worked or direct one-to-one allocation. Indirect labor costs are accumulated as overhead and then allocated to products on a reasonable allocation basis.
7. Grouping and presentation of cost sheets
Direct labor costs are categorized as prime costs and are allocated first in the cost sheet. Direct labor costs are categorized in overhead costs and are allocated after all direct costs are allocated in the cost sheet.
8. Example
Direct labor includes machine operators, packers, assembly line workers, etc. indirect labor including housekeeping and maintenance staff, security, accounting staff, etc.
9. In accounting records
Direct Labor Accounting
Direct labor costs are assigned to all units produced during the reporting period. The basis for assigning costs is the number of labor hours actually used in the production process.
Indirect Labor Accounting (Factory)
Indirect factory labor costs are assigned to the cost pool, from which they are allocated to units produced during the reporting period. Depending on the sophistication of the allocation, several cost pools can be used, each of which has a separate allocation methodology.
For example, the cost pool for real estate costs could accumulate factory rent, and then be allocated based on the number of square footage used. Meanwhile, another set of costs for maintenance costs can accumulate labor costs and maintenance equipment, and is allocated based on machine hours used.
Indirect Labor Accounting (Administrative)
Administrative costs are not directly charged to expenses in the period in which they are incurred. It never appears on the balance sheet as an asset. According To ZPZ Education What is Direct Labor & Indirect Labor?