Direct labor cost is one of the key components of fundamental business benchmarks such as efficiency and profitability. It’s no wonder, then, that understanding and calculating this financial variable is a big part of whether or not your business runs smoothly.
In this article, our experts at Sling discuss the ins and outs of this expense, show you how to calculate it, and give you tips for controlling it within your business.
Direct Labor (Managerial Accounting)
What is indirect labor?
Here are more examples of indirect labor:
Companies can factor in overhead costs to their products and services using indirect labor costs. They can sum up all overhead costs and add to the cost per unit sold. This calculation aids companies in measuring the final cost charged to the customer. This may cause an increase in a products cost since youre adding overhead costs to the production cost. A company may need to charge more for a product so they can compensate for all indirect labor employees.
What is direct labor?
The nature of an organization determines the types of employee wages considered direct labor expenses. Direct labor in manufacturing businesses includes employees who work directly in production, including:
In service-based businesses, direct labor refers to employees who provide the services, such as:
How to calculate direct labor cost
Here are the steps to calculate direct labor costs:
1. Identify which expenses are direct labor expenses
2. Add direct labor expenses
Determine total expenses for direct labor for a given time period, including:
3. Calculate hourly labor costs, if needed
You can calculate the per-hour direct labor cost by dividing total direct labor expenses for a given time period by the number of hours worked during that period.
For instance, if you determine the total direct labor expenses for an employee are $60,000 per year and the employee works 2,000 hours per year (40 hours a week for 50 weeks of the year), divide $60,000 by 2,000 to determine the employees direct labor cost per hour: $60,000/2,000 = $30 per hour.
4. Calculate labor costs for other time periods
Now that you have the per-hour direct labor cost, you can use it to determine daily, weekly, monthly or quarterly direct labor costs for the employee.
For instance, if the employee works 40 hours a week, the direct labor cost to the company for the week is 40 multiplied by $30, or $1,200.
Direct labor examples
Here are several examples of using direct labor costs. The first demonstrates finding hourly direct labor expenses and the second shows how to calculate direct labor costs for a quarter:
Brew Good Coffee produces and distributes whole bean coffee. Its facility employs 15 employees working on producing, packaging and delivering bags of coffee. Brew Goods owners want to calculate the hourly direct labor costs of its factory employees for the previous year.
First, the owners determine the total expenses for the 15 employees by adding up wages, benefits and other contributions. The amount is $750,000, which represents total direct labor costs for the year.
Next, the company adds up the number of hours the factory employees worked in the past year. Ten employees worked 40 hours a week for 50 weeks for a total of 20,000 hours (10 x 40 x 50 = 20,000). The other five employees worked 35 hours a week for 48 weeks of the year for a total of 8,400 hours (5 x 35 x 20 = 8,400). This makes the total number of hours worked 28,400 hours (20,000 + 8,400).
Finally, Brew Good can divide total direct labor costs by total number of hours to figure out its per-hour direct labor cost.
Per-hour direct labor costs = $750,000 total direct labor costs/28,400 hours = $26.41 per hour
Bright Blooms is a flower shop in a large city. The owner wants to determine the companys direct labor costs each quarter.
The company employs six florists who make floral arrangements, two traveling floral consultants to help with events and two delivery drivers. The florists earn a yearly salary of $45,000 each. The floral consultants make $35 per hour, and the delivery drivers make $25 per hour.
The floral consultants each worked 120 hours per month in the previous quarter, which totals 360 hours per consultant. In all, the two consultants worked 720 hours in the quarter for earnings of $25,200.
The delivery drivers worked 40 hours per week during the quarter, totaling 960 hours for both drivers. At $25 per hour, they made $24,000.
In addition to employee wages, the Bright Blooms owner spends $200 each month on benefits and insurance for employees. The total cost of benefits for the quarter is $200 times three months, which is $600 per quarter per employee. With 10 employees, the cost is $6,000.
The owner can calculate direct labor costs for the quarter by adding up all these expenses:
Quarterly direct labor costs = $67,500 + $25,200 + $24,000 + $6,000 = $122,700
What is direct labor example?
What are examples of direct labor costs?
What is a direct labor employee?
One example of a direct labor cost is the hourly salary of a quality assurance inspector adjusted to include healthcare benefits and short-term disability. Another example could be the annual salary of a welder who works on the production line of a steel parts manufacturing company.