Direct Labor Costs

Article byWallstreetmojo Team
Edited bySusmita Pathak
Reviewed byDheeraj Vaidya, CFA, FRM

What Are Direct Labor Costs?

Direct labor costs refer to the total cost incurred by the company for paying the wages and other benefits to the company’s employees against the work performed by them, which are related directly to the manufacturing of the product of the company or for the provision of the services.

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For eg:
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It is one of the significant components of the product cost of the companyProduct Cost Of The CompanyProduct cost refers to all those costs which are incurred by the company in order to create the product of the company or deliver the services to the customers and the same is shown in the financial statement of the company for the period in which they become the part of the cost of the goods that are sold by the company.read more where the other components of the product cost include direct material cost and manufacturing overhead costsManufacturing Overhead CostsManufacturing Overhead is the total of all the indirect costs involved in manufacturing a product like Property Tax on the production premise, Remunerations of maintenance personnel, Rent of the manufacturing building, etc. read more.

Direct Labor Costs Explained

Direct labor cost is one of the significant components of the company’s product cost. It includes the total paid as wages or other benefits to the company’s employees. They are related directly to the manufacturing of the company’s product or the provision of services.

The cost of the direct labor incurred by the company during the period is required to calculate the company’s product cost, where the amount paid to workers who are working in the company but are not involved directly with the product of the company is not to be considered.

The company can include the amount paid to the full-time employees of the company, part-time employees of the company, the company’s temporary employees, and the workers appointed on a contractual basis, where they are involved directly in the manufacturing or the handling of the goods.

The total value of the direct laborDirect LaborDirect labor costs refer to the total cost incurred by the company for paying the wages and other benefits to its employees against the task performed by them, which are straight away related to the manufacturing of the products or provision of the services.read more expense does not only include the wages paid to the employees. It also includes the other paid directly related to the products, such as payroll taxes associated with employee wages, workers’ compensation insurance, life insurance, medical insurance, and other company benefits.

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Components

The following components are included:

Components of Direct Labor Costs

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  • Wages – The wages are included in the direct labor cost. These are paid to the employees generally on an hourly basis for the goods production or provision of services.
  • Payroll Taxes – These include Payroll taxes of employees engaged in the manufacturing of the products or provision of the services count.
  • Worker’s Compensation – This includes worker’s compensation paid to employees engaged in the manufacturing of the products or provision of the services.
  • Health Insurance – It includes health insurance premiums paid on behalf of those employees who are engaged in the manufacturing of the products or provision of the services.
  • Life Insurance – This includes life insurance premiums paid on behalf of employees engaged in manufacturing the products or provision of the services count. Other benefits paid to or on behalf of employees involved in the manufacturing of the products or provision of the services are also included.

Formula

As stated above, these costs are sum total of the payments to be made to employees in the form of salaries, wages, and other benefits in exchange for the work they do. Hence, there is no specific direct labor costs formula to consider, but in case the number of hours or period is the basis for payment, companies can determine these costs using the following equation:

Direct Labor Cost = Pay Rate*Time taken to accomplish a task or project

Calculation Example

From the following information, let us understand how to calculate the direct labor cost of the company for the month ending on September 30, 2019.

  • Wages paid to the employees for the work related directly to the manufacturing of the product: $ 150,000
  • Raw material purchased for $500,000
  • Wages paid to the employees for the work that is not related directly to the manufacturing of the product: $ 110,000
  • The health insurance premium paid on behalf of those employees who are engaged in the manufacturing of the product: $ 5,000

Solution:

This will be calculated as follows:

Direct labor Costs Examples

Advantages

  1. Segregating the direct labor cost from the total labor costs helps in knowing the total wages or other benefits to the company’s employees against the work performed by them, which are related directly to the manufacturing of the product of the company or for the provision of the services. And the cost of labor cost left after deducting this cost from the total labor costs will be the indirect labor cost of the company.
  2. It is one of the significant components of the company’s product cost, i.e., the cost of the direct labor incurred by the company during the period is required to calculate the product cost of the company.

Disadvantages

  1. There are certain costs related to employees of the company where it is difficult to identify whether the cost is the direct labor cost or indirect labor cost.

This article has been a guide to what are Direct Labor Costs. We explain it with a formula, an example to show the calculation, components, advantages & disadvantages. You can learn more about it from the following accounting articles –

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