To finance their operations, businesses must pay a variety of costs, which frequently include paying wages to employees who provide services to the company. Depending on whether a particular worker contributes directly to the creation of goods, labor costs are frequently divided into direct labor costs and indirect labor costs in business management and finance.
Elements of cost | Direct and Indirect: Material, Labor, & Expenses
Why is indirect labor important to understand?
Indirect labor is a crucial part of a companys success. Companies need to recognize the value of indirect labor because it is used to calculate profitability and set prices for goods and services.
For example, if a business employs an accountant, they are responsible for reviewing reports that detail financial transactions for the entire business. When they record a company’s transactions across all departments, they can assess the performance of the business and provide advice on how to move forward with spending.
Because they make decisions that have an impact on the business’ performance without producing goods and services, accountants are considered indirect labor. The annual salary of the accountant is the indirect labor cost for the employee who assists the company in determining how to manage spending moving forward.
Knowing the value of indirect labor enables a business to add overhead expenses to its goods and services. They can add the cost per unit sold to the total of all administrative expenses. This calculation helps businesses determine the total cost a customer will pay. Given that you are increasing the production cost by adding overhead expenses, the price of a product could go up. To cover all indirect labor employees, a business may have to raise the price of a product.
What is indirect labor?
Employees who perform tasks that benefit the business’ performance but are unrelated to the production of goods and services are referred to as indirect labor. They are employed in departments like the administrative, accounting, and engineering ones. Due to the fact that indirect labor costs extend beyond a single project or service, businesses include them in their overhead costs.
What is the difference between indirect and direct labor?
Costs associated with the production of goods and services include direct labor. Businesses determine the cost of direct labor by the number of hours required to produce a product for customers. Employees who assist in other areas of the business are only charged for indirect labor, which is not used in the production process.
How to calculate indirect labor
Use these steps to calculate indirect labor costs:
1. Identify the number of hours employees worked
To start your calculation, determine how many hours each indirect labor employee put in. Keeping track of employees’ work hours reveals how much time they spent on activities other than production. Accounting software and records can be examined by accountants to determine how many hours each department’s staff members put in. To accurately calculate the number of indirect labor hours, they can divide the workforce into those who worked in production and those who worked in other departments.
2. Subtract time-off for each employee
Incorporate time off if the employee’s compensation package includes paid time off. Paid time off is taken into account, ensuring that it is not counted toward an employee’s total number of hours worked, improving calculation accuracy. Employees may receive paid sick leave or pay to attend conferences or training sessions on behalf of the employer, which would not be included in the indirect labor calculation.
3. Multiply hourly employees total hours worked by their hourly wage
Multiplying the annual hours worked by the hourly wage of an employee Making this calculation enables the business to determine how much indirect labor costs for one employee. If an employee worked 1,715 hours overall last year at a rate of $15 per hour, multiply 1,715 by 15, and you would pay that employee $25,725 annually. Do the math for all hourly workers and include it in your indirect labor costs.
4. Add employees annual salaries to your calculations
Total the yearly salaries paid by the business to salaried employees. After completing steps one through four, businesses must make sure they finish this step so they can compare the total indirect labor costs for hourly workers and salaried workers.
After completing those steps, you can assess whether spending needs to be adjusted by comparing them to overhead costs. To determine how many salaries to include in the calculation you made for hourly employees, determine the number of salaried employees in the company.
Examples of indirect labor
Here are examples of indirect labor:
To ensure that all aspects of projects are completed on time, production managers supervise a team of workers. They give staff members detailed instructions on how to complete tasks and expectations regarding the production process. If customers notify them, they can notify employees about changes to the scope of projects.
A security officer ensures that the workplace is secure so that workers can perform their duties there. They can conduct a building patrol to spot any suspicious activity and determine whether it poses a risk to the workers. They might work morning or evening shifts to maintain building security around-the-clock.
Once the company’s products and services are made available to the public, marketing personnel promote them. They create content for their company’s social media pages, publish it there, and optimize it so that users can find it there. Marketing professionals assess the effectiveness of engagement to determine whether they are reaching their target audience and modify their company’s marketing strategy in light of the information they have gathered.
Employees in human resources find, interview, and hire personnel for various departments. They collaborate with management to identify the best practices for employee development and training, and they choose the appropriate payroll and benefits structure to compensate workers. To reflect company policy, human resources can update the employee handbook.
What kind of cost is indirect labor?
- Identify the number of hours employees worked.
- Subtract time-off for each employee.
- Multiply hourly employees’ total hours worked by their hourly wage.
- Add employees’ annual salaries to your calculations.
What is an example of an indirect job?
Paying workers who perform tasks that do not directly contribute to the production of goods or the rendering of services, such as support staff who enable others to produce goods, is referred to as indirect labor cost.