What is the Cost of Labor?
Cost of labor can be defined as the remuneration paid in the form of wages and salaries that are paid to the employees including allowances, payroll taxes, and such other benefits and can be sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.
It is an amount paid by employers towards the workers’ wages, benefits, and payroll taxes. It can be classified into direct costs and indirect costs. Direct costs are such costs that can be directly allocated to the finished goods. In contrast, indirect costs are such costs that cannot be directly associated with the overall production costs of the finished goods.
Formula to Calculate
The cost of labor is broken into direct and indirect costs. So, the formula that can be used for calculation is as follows:
- Total direct cost is the total cost of the company paid to its employees for work that relates directly to the manufacturing of products or the provision of services.
- Total indirect cost is the total cost of the company paid to its employees for work that does not relate directly to the manufacturing of product or provision of services like amount paid to support labor etc.
Examples of the Cost of labor
ABC Company manufactures dolls and sells them in the market. During a period, ABC Company paid wages of $100,000 to the assembly workers for making dolls in the factory and $15,000 to the security guards at the manufacturing plant. Calculate the cost of labor of the company using the information given.
Step 1: Calculate Direct Labor Expense
From the information given, the wages of $100,000 paid to the assembly workers for making dolls in the factory are related directly with the manufacturing of the product of the company, and it is the company’s direct labor cost.
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So for the period total direct labor expense = $100,000
Step 2: Calculate Indirect Labor Expense
From the information given, the wages of $15,000 paid to the security guards at the manufacturing plant are related not directly with the manufacturing of the product of the company, and it is the company’s indirect labor cost.
So for the period total indirect labor expense = $15,000
Step 3: Calculate
- = $100,000 + $15,000
- = $115,000
Cost of labor is a highly important aspect for employers as it helps them in the following matters:
- Management of Costs: It helps employers in managing costs. Employers can easily identify workers that are not performing as per the expectations and requirements. In this way, they can go for cost-cutting as and whenever required and got rid of undeserving and under-performing workers.
- Outsourcing: For estimating the updated cost structure of a business, management must understand all its labor costs before outsourcing any sort of activities to a seller or a supplier.
Difference Between Cost of Labor and Cost of Living
Both differ from each other on different parameters. The differences are given below:
- Meaning: Cost of living can be defined as the costs that are necessarily borne by a customer to maintain a standard of living in a particular geographical area. On the other hand, the cost of labor can be defined as the costs that are borne by an employer in the form of salaries or wages, payroll taxes, and other benefits paid to a worker.
- A consumer bears the cost of living, and he or she can be a worker, employer, businessman, unemployed individual, etc. On the other hand, the cost of labor is borne by an employer.
Some of the benefits are given below:
- It helps the management of an organization in managing the labor costs of an organization as it allows the same in the identification of such employees that are under-performing. The management during lay off can get rid of the identified under-performing employees instead of the ones that are performing and delivering as per the expectations.
- It allows the management to compare the costs of labor to his output or performance.
- It allows the management to get rid of underperforming employees.
- Helps the management in avoiding mistakes and creating a labor budget for the company.
Some of the disadvantages are given below:
- The calculation totally ignores the time factor in the case of workers that are paid on a piece-rate basis.
- There is hardly any distinction drawn between the performance of workers that work on machines and ones that work manually.
- There is hardly any distinction made between skilled and unskilled workers.
- There is no distinction drawn between fixed cost and variable cost.
The cost of labor is merely an amount that is paid by an employer to his workers. These costs include salaries, wages, payroll taxes, and benefits paid by an employer. It helps the management of an organization in the management of costs, outsourcing, union negotiations, etc.
This has been a guide to what is the cost of labor and its definition. Here we discuss an example and formula to calculate the cost of labor along with advantages and disadvantages. You may learn more about financing from the following articles –