Direct Labor Cost

Definition

Direct labor cost is essentially the work related expenses that can be attributed to the actual manufacturing of a product/good. In case of service industry, direct labor cost is referred to the labor cost needed for providing a particular service. Thus, direct labor cost does not involve employees who are not involved in the production, like office and administrative staff members. It only consists of personnel who are responsible for setting up as well as maintaining the equipment.

How to Measure Direct Labor Cost?

In order to measure direct labor cost accurately, an entity should take all the expenditures and not merely wages, into consideration. Therefore, the entity will typically include social security related cost that is paid by the employer, unemployment related taxes and medicare expenses and worker’s compensation related insurance. In addition to this, the entity must also include health insurance related expenditures and pension plan contributions into consideration. Companies may also have to consider an allowance amount for recruitment and training of workers to arrive at the total cost of labor.

Calculation of Direct Labor Cost

In order to calculate direct labor cost, the entities must make sure that they include every detail that essentially forms a cost for them in terms of keeping and hiring an employee. This amount is not merely what is paid to the person but also includes the extent to which keeping an employee impacts the company’s payroll tax related contributions, benefits costs, insurance premium amounts etc.

The company must establish a standard or model rate for the purpose of analyzing direct labor cost effectively. This rate is typically an estimation of what the company expects the direct labor cost would be in usual conditions. Thus, there are basically two main components of this particular model i.e. the estimated cost of 1 hour of direct labor as well as the number of hours that a labor spends in producing a product/unit. For example, if a company’s total direct labor cost for one hour is fifteen dollars and it expects to utilize 0.5 hours on every single unit during production, then if it manufactures one thousand units per week, then its standard cost of labor would be seven thousand five hundred dollars.

However, in direct labor cost calculations, companies should watch out for variance in efficiency and rate of labor.