Direct Labor and Indirect Labor: Definitions, Examples, Differences

This bifurcation is done based on their traceability to the units produced. Small businesses should collect appropriate direct and indirect labor data to properly analyze the total labor costs across departments. Essentially, it means these costs do not become a part of the cost of the underlying product. Nonetheless, indirect labor is still an expense incurred by a company. Despite the name, indirect labor is still essential in running a business and its operations.

In addition to what the company pays the employees, it must consider costs to retain employees, such as payroll tax contributions, insurance premiums, and benefits costs. Direct labor includes the cost of regular working hours, as well as the overtime hours worked. It also includes related payroll taxes and expenses such as social security, Medicare, unemployment tax, and worker’s employment insurance.

  • 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.
  • Examples of indirect labor are wages paid to workers for sweeping, cleaning, supervising, inspecting, and issuing raw materials.
  • If the employees are happy with the payment, the entity can reduce the chances of employee turnover and thereby save recruitment and training expenses.
  • As a result of this unfavorable outcome information, the company may consider retraining its workers, changing the production process to be more efficient, or increasing prices to cover labor costs.
  • For example, you had two indirect employees work in the month of June.

Hence, variance arises due to the difference between actual time worked and the total hours that should have been worked. Direct labor is assigned to the core manufacturing process or service delivery process. Direct labor refers to all the workers or employees directly involved with the manufacturing process. Companies can identify and trace direct costs to a specific product or service. However, tracking indirect costs and associating them with one item requires complex processes.

However, such costs are required in the production process of goods and must, therefore, be added to the overall cost of the product. While they’re not directly involved in production, indirect labor plays a supporting role in the manufacturing process. To calculate indirect labor, you’ll need to add up the hours that any indirect employees worked and calculate their salary accordingly. If your employee worked 180 hours in June, his total direct labor cost would be $4,050. Direct labor is considered to be a direct cost, which means that it varies directly with revenue or some other measure of activity.

Indirect Labor

This is a favorable outcome because the actual hours worked were less than the standard hours expected. If the actual rate of pay per hour is less than the standard rate of pay per hour, the variance will be a favorable variance. If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable.

  • Such employees, however, do not include supervisors or clerical staff.
  • While direct labor is essential for the production process, indirect labor is important in the functioning of the other departments.
  • A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.
  • Sling really is the turnkey solution for all your scheduling and direct-labor-cost-management needs.
  • There are two components to a labor variance, the direct labor rate variance and the direct labor time variance.

You can find this by averaging together all the absences and illnesses of individuals who work in similar positions to the hypothetical employee in question. 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. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent.

Standard Costing Outline

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. Labor yield variance arises when there is a variation in actual output from standard. Since this measures the performance of workers, it may be caused by worker deficiencies or by poor production methods.

Types of Direct Costs

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. 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. 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. Since labor is one of the biggest expenses on a manufacturer’s income statement, cost accountants naturally want to track and control these costs by separating them from indirect costs.

The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. That’s why we’re going to reduce the annual cost down to an hourly cost.


Doctors, for example, have a time allotment for a physical exam and base their fee on the expected time. Insurance companies pay doctors according to a set schedule, so they set the labor standard. If the exam takes longer than expected, the doctor is not compensated for that extra time. Doctors know the standard and try to schedule accordingly so a variance does not exist. If anything, they try to produce a favorable variance by seeing more patients in a quicker time frame to maximize their compensation potential.

Direct labor efficiency variance

Tracking both direct and indirect labor costs is important for all business owners, particularly those that manufacture products. 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. Direct labor costs include the wages, salaries, and benefits paid to these employees. They can also include other labor-related expenses directly tied to the production process.

Since the direct labor is regarded as purely a variable manufacturing cost, it should vary with the output volume produced by the entity. Such employees, however, do not include supervisors or clerical staff. Stated again for clarity, this expense refers to salaries, wages, and benefits paid to workers directly involved in performing a service or manufacturing a product. The reality of the concept, though, goes well beyond just the hourly rate you pay your employees. Watch this video presenting an instructor walking through the steps involved in calculating direct labor variances to learn more. The actual hours used can differ from the standard hours because of improved efficiencies in production, carelessness or inefficiencies in production, or poor estimation when creating the standard usage.

What Is Labor?

Once you’ve identified your cost and how it applies to your rate of production, you can tweak any number of variables and procedures within your business to achieve the result you’re after. Of course, employees are allowed to clock in early for work — and get paid for that time — but only if they have your permission first. To get a real sense of the cost involved in the manufacture of your widgets, we need to see how the number we calculated in the previous step impacts your business. That number tells you that when you’ve factored in all the other employee expenses, you’re paying your employee $22.80 per hour to produce widgets.