Direct Vs Indirect Labor Cost: An Expert Accounting Guide

While direct labor comprises work done on certain products or services, indirect labor is employee work that can’t be traced back or billed to services or goods produced. The indirect labor cost is a major component that needs to be considered while starting a manufacturing unit. It also includes the salaries and wages of employees working on non-manufacturing work. Understanding the importance of indirect labor costs can help companies reduce their expenses. The three general categories of costs included in manufacturing processes are direct materials, direct labor, and overhead.

Security guards, janitors, and accountants, for example, are part of indirect labor. This will allow a company to more readily identify how much it should budget for indirect labor costs. The administrative indirect labor cost, on the other hand, is treated as period cost and is expensed in the period of incurrence.

  1. This distinction is important from an accounting perspective, since the two types of labor are treated differently.
  2. Direct labor refers to employees who are directly involved in production.
  3. Calculate this for all hourly employees and add it to your indirect labor costs.
  4. By doing this, a company will be able to see where price reductions can take place while still achieving desired margins.
  5. Returning to the example of Dinosaur Vinyl’s order for Macs & Cheese’s stadium sign, Figure 4.7 shows the materials requisition form for Job MAC001.
  6. (ii) Maintenance employees, such as mechanics, workshop cleaners, and so on.

Fixed indirect labor costs are expenses that remain unchanged even when production increases or decreases. In order to have an accurate estimate of labor costs, you’ll need to track both direct and indirect labor costs. Just like direct labor costs, it’s important to track indirect labor costs.

They give employees precise instructions and expectations about the manufacturing process, as well as the actions they must take to complete their responsibilities. If clients notify them of changes to the scope of projects, they can notify staff. is not involved in the manufacturing process directly. Direct labor consists of people who do work on specific products, i.e.,  they make things that the company sells.

It represents the overhead to the business needed to support the level of operations. Like direct labor, a significant part of total indirect labor cost consists of fringe benefits, employer’s contributions and payroll taxes etc. It’s important to keep direct labor costs separate from other labor costs, since you’ll need to have access to these costs in order to accurately calculate total production costs. Direct labor costs are the expenses incurred by paying the wages of your direct labor employees.

What is Indirect Labor Cost?

How many people are necessary to adequately provide for the company? Some construction businesses have a single person behind the curtain. When both administrative and production activities occur in a common building, the production and period costs would be allocated in some predetermined manner. But note that while production facility electricity costs are treated as overhead, the organization’s administrative facility electrical costs are not included as overhead costs. Instead, they are treated as period costs, as office rent or insurance would be. The last category of manufacturing overhead is the overhead itself.

Indirect Labor Examples

Both direct labor costs and indirect labor costs are important for an entity’s optimum functioning. In the case of indirect labor, however, the expense is recorded as overhead rather than the cost of products sold. Sue and Tammy work for a T-shirt company that places logos on t-shirts.

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Small businesses should collect appropriate direct and indirect labor data to properly analyze the total labor costs across departments. They are, however, not directly related to the transformation of raw materials into final commodities. To begin your computation, find out how many hours each indirect labor employee worked. The number of hours worked by employees reveals how much time they spent on tasks other than production. Accountants can use their accounting software and records to determine how many hours each department’s employees worked.

Direct costs vary with the change in the number of units produced by the entity. They are considered relevant when making specific business decisions as they cannot be avoided. Direct labor costs can be traced to the specific production process, products, or services. Direct labor costs are a cost center and normally account for its productivity in terms of working hours, production per hour or day basis, etc. Knowing the value of indirect labor enables a corporation to add overhead fees to its products and services.

Relevant formulas

Sam worked 80 hours with a salary of $10/hour and fringe benefits of $100, while Debra worked 120 hours with a salary of $15/hour and fringe benefits totaling $125. Once a plant’s performance gaps are identified, they can be targeted by systematically examining and understanding the factors behind them. Typically, seven impact drivers matter the hidden costs of cause marketing most for indirect functions (Exhibit 3). However, several steps have to be taken in order to compare two companies or plants, as there is typically very little standardization across indirect operations. Businesses will pay salaries and benefits to company employees in a typical contract and hourly or pre-project costs to contractors.

Indirect labor costs are not an important component of total production cost. The cost of direct labor is charged to all units produced during the reporting period. The basis for charging the cost is the number of hours of labor actually used in the production process. Indirect labor is a category of indirect cost and refers to those employees that assist the direct labor in the performance of their work. They are not involved directly in the service or production process.

Machine operators are tasked to operate and maintain the machinery used during manufacturing. They ensure the machines produce high-quality products and are properly maintained. They are actively involved in the manufacturing process and may hinder production if they do not perform their task. Direct labor is calculated by adding the agreed cost of working hours to overtime hours. Direct labor costs are usually variable because they rise and fall depending on the production costs. While many types of production processes could be demonstrated, let’s consider an example in which a contractor is building a home for a client.

The company’s accountant should be able to provide the necessary figures. The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters. If these hidden costs climb too high, a company can go out of business.

For each cost, identify its origination in a job order costing environment. Job order costing requires the assignment of direct materials, direct labor, and overhead to each production unit. The primary focus on costs allows some leeway in recording amounts because the accountant assigns the costs.


Every day, you produce and sell a variety of toys for kids of all ages. On a daily basis, you have 20 employees on your payroll, ranging from those that operate the machines that produce the toys to those that package them. When orders decline, the management may lay off production workers, i.e., direct labor.

They can distinguish between employees who worked in production and those who worked in other departments in order to calculate the number of indirect labor hours accurately. In order to boost efficiency, a company’s indirect labor allocation defines who it needs to hire. Companies budget for indirect labor expenditures if they require assistance outside of the production crew. When a corporation identifies which functions it requires assistance with, it is more likely to streamline corporate operations and fulfill its objectives.

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