First, calculate the direct labor hourly rate that factors in the fringe benefits, hourly pay rate, and employee payroll taxes. The hourly rate is obtained by dividing the value of fringe benefits and payroll taxes by the number of hours worked in the specific payroll period. The company can make the journal entry for direct labor and indirect labor that incurs during the period by debiting the labor cost account and crediting the wages payable account and the payroll taxes payable account. On the other hand, the indirect labor cost is the cost that cannot be traced to a single job or a single unit of product as such cost is usually related to the production as a whole. For example, the salary of the quality control and inspection personnel usually contributes to all units of goods in the production. Direct labor costs are often considered a cost driver for allocating overhead expenses under activity-based costing and are regarded as prime costs in the cost sheet.
For example, assume that employees work 40 hours per week, earning $13 per hour. Get the sum of the benefits and taxes (100+50) and divide the figure by 40 to get 3.75. Direct labor refers to the salaries and wages paid to workers directly involved in the manufacture of a specific product or in performing a service. For a business that provides services to its customers, direct labor is the work performed by the workers who provide the service directly to the customers, such as auditors, lawyers, and consultants.
What is Labor Cost?
During June 2022, Bright Company’s workers worked for 450 hours to manufacture 180 units of finished product. The standard direct labor rate was set at $5.60 per hour but the direct labor workers were actually paid at a rate of $5.40 per hour. Find the direct labor rate variance of Bright Company for the month of June. He receives a base wage of $20,000 annually, and his benefits include healthcare and retirement contributions, amounting to $5,000, while the company pays $2,500 in taxes related to his employment.
- For a business that provides services to its customers, direct labor is the work performed by the workers who provide the service directly to the customers, such as auditors, lawyers, and consultants.
- First, calculate direct labor cost for each florist in one quarter by dividing the florist’s earnings ($60,000) by the period (quarter).
- Labor includes the workforce used by any company to assist, manage, supervise and monitor its manufacturing processes.
- Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs.
This bifurcation is done based on their traceability to the units produced. Sunshine Florals employs six florists for floral arrangements, two traveling floral consultants for events, and two delivery drivers. Each florist earns an annual salary of $60,000, floral consultants earn $40 per hour each, and the delivery drivers earn $25 per hour each.
Labor Cost Formula
Cost accounting pertains to the study of all types of costs, including direct and indirect labor costs in manufacturing a product or rendering core business services. Direct labor rate variance is equal to the difference between actual hourly rate and standard hourly rate multiplied by the actual hours worked during the period. The variance would be favorable if the actual direct labor cost is less than the standard direct labor cost allowed for actual hours worked by direct labor workers during the period concerned. Conversely, it would be unfavorable if the actual direct labor cost is more than the standard direct labor cost allowed for actual hours worked. Tracking both direct and indirect labor costs is important for all business owners, particularly those that manufacture products.
Finish Your Free Account Setup
Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. We follow strict ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
Using Direct Cost to Allocate Overheads
The good news for you or your bookkeeper is that if you’re using accounting software, much of the heavy lifting is done for you. The variance is obtained by calculating the difference between the direct labor standard cost per unit and the actual direct labor cost per unit. If the actual direct labor cost is lower, it costs lower to produce one unit of a product than the standard direct labor rate, and therefore, it is favorable. In addition to basic wages and salaries, an entity’s direct labor cost includes all costs and expenses needed to hire and keep direct labor workers in the organization. These costs and expenses take the form of relevant federal and state taxes, contributions and benefits provided by employers for the support and wellness of workers. Due to this reason, an entity’s total direct labor cost is often much higher than just the basic production related wages or salaries paid to workers as their remunerations.
For example, let’s say you’re a practicing attorney that employs a receptionist and a research assistant. Although both of your employees play a vital supporting role in keeping your practice running, both are considered indirect labor, as neither provides services directly to the customer. Direct labor refers to any employee that is directly involved in the manufacturing of a product. If your business manufactures bicycles, the employees producing the bicycles are considered direct labor. While both are crucial for the company, both play different roles in calculating profits.
Fiduciary Accounting: Definition & Importance
The other two variances that are generally computed for direct labor cost are the direct labor efficiency variance and direct labor yield variance. Labor rate variance arises when labor is paid at a rate that differs from the standard wage rate. Labor efficiency variance arises when the actual hours worked vary from standard, resulting in a higher or lower standard time recorded are salaries fixed or variable costs for a given output. The issue of direct vs. indirect labor depends upon the business and industry type. Accounting for direct and indirect labor is essential because they contribute to the final cost of production and impact the pricing decision. While direct labor is essential for the production process, indirect labor is important in the functioning of the other departments.
