Direct Labor Definition
Direct labor is the cost of wages and benefits paid to the employees who are directly involved in manufacturing and producing the finished product. It is the cost of labor that is separately and readily traceable to the finished product.
In simple words, when a business manufactures products, direct labor is considered to be the cost of the labor that produces goods, such as machine operators. When a business provides services, it is considered to be the cost of those people who provide services directly to customers, such as consultants and lawyers.
There are two basic components which are as follows-
#1 – Monetary Benefits
These include Basic wages, Dearness allowance, Production bonus, Overtime allowance, Employer’s contribution to Provident fund, Employer’s contribution to Employee state insurance, Pension after retirement and Gratuity.
#2 – Fringe Benefits
These include free or subsidized food, free or subsidized housing, Free or subsidized education to worker’s children, Holiday facility, free medical facilities, and recreational facilities.
Direct Labor Cost Formula
In order to calculate it, we need two things: a standard cost of one hour of labor and the number of hours needed to produce one unit.
It is represented as below,
To calculate the standard hourly rate of labor, we will add all the components i.e. basic wages, dearness allowance, bonus, overtime allowance, employer’s contribution to provident fund, insurance premium, pension and any other benefit provided by the company and divide the same with the total number of hours worked.
To calculate the number of hours required to produce one unit; divide the total labor hours by the number of units that the workers are expected to complete during that period.
Example of Direct Labor
AB Ltd is a furniture manufacturer having a labor workforce of 10 people, working 40 hours per week, manufacturing 500 units and they earn an average of $20 per hour. Payroll taxes and other benefits include $5,000. Calculate direct labor per unit.
Calculation of Total Weekly Hours Worked
Total weekly hours worked = No. of hours in a week * No. of workers
- = 40 * 10
- = 400 Hours
Calculation of Total Labor Cost
Total labor cost= Basic hourly rate * total number of hours worked + Taxes and other benefits paid
- = 20 * 400 + 5000
- = 13,000
Calculation of Labor Cost per Hour
Labor cost per hour = Total labor cost / Total number of hours worked
- = 13,000/400
- = 32.50
Time Required to Complete One Unit
The time required to complete one unit = Total direct labor hours/no of units that the workers manufacture in a given time
- = 400 / 500
- = 0.80 Hours
Direct labor Cost per unit = Standard/Average rate of one hour of direct labor * number of hours required to produce one unit
- = 32.50 * 0.80
- = 26
Direct labor is the total payroll cost related to a particular product or service. Labor is one of the significant costs that companies incur in the course of their business. Overestimating the cost may lead to overpricing the goods and lose customers to competitors. By underestimating this cost, the business may lead to setting prices that are too low to cover the expenses and making an adequate profit.
Hence, it is important to correctly calculate the cost as it is an important factor in considering the overall costing of the product.
Changes in Direct labor
It is considered as the variable cost, which means any change in labor cost has a direct impact on the total revenue/total cost of the product. The direct labor changes with the change in the number of units produced.
Difference Between Direct and Indirect Labor
It is important to correctly distinguish between direct and indirect labor as their accounting treatment is different. For this, we first have to understand their meanings. Direct Labor includes those employees that are directly involved in the manufacturing process such as, employees working on the machines and the employees directly involved in the process of converting the raw material to finished goods. Indirect labor includes the supervisory and support staff. Equipment maintenance staffs, security workers fall under this category.
Direct labor is part of the manufacturing cost and it is considered as the variable cost because it changes with change in the number of units produced. On the other hand, indirect cost is considered as fixed cost as it remains constant even if the factory output becomes zero.
Thus, it is an important component of the total manufacturing cost of the product. It is important to correctly identify and calculate this cost. Also, it is not only the payroll cost, it includes each and every cost incurred in hiring and keeping the employees. In order to calculate the total labor cost, the company not only includes salary pay-outs but should also consider payroll tax contribution, employer’s provident fund contributions, insurance premiums, and other benefits costs.
This has been a guide to Direct Labor and its definition. Here we discuss the formula to calculate direct labor expense along with examples, components and its differences from indirect labor. You may also take a look at the following articles –