Companies that produce, alter or manufacture goods always incur direct labor cost. Direct labor cost is the total cost of employing workers that work directly on a manufacturing product. Direct labor, direct materials and manufacturing overhead comprise a company's product costs. The sum of these three costs equals total inventory costs under generally accepted accounting principles.
Who's Part of Direct Labor Costs
Direct labor can include full-time employees, part-time employees, temporary employees and contract workers, as long as they are directly involved with manufacturing or handling the goods. Workers that work in the facility but are not directly involved with the product aren't part of direct labor cost. For example, an assistant that sweeps and mops a brewery room floor but never works with the beer itself is part of indirect labor costs, not direct labor costs. Employees that oversee operations but aren't involved in the product, like a plant manager, are part of manufacturing overhead costs rather than direct labor costs.
Calculating Direct Labor Costs
To calculate direct labor costs, sum the total eligible costs incurred during the year. Direct labor costs include the following components:
- Payroll taxes
- Worker's compensation
- Direct recruiting costs
- Health insurance
- Dental insurance
- Life insurance
- Company 401(k) and pension contributions
- Any other fringe benefits paid on behalf of direct labor employees.
For example, if a business incurs $50,000 in wages, $10,000 in payroll expense, $10,000 in workman's compensation and $40,000 in benefits for direct labor employees, direct labor cost is $110,000.
Direct labor costs are calculated based on what workers have earned rather than what they've been paid. For example, say that a set of direct labor workers worked the last two weeks of December 2015 but aren't paid until January 2016. The wages and corresponding benefit expenses for those two weeks should be included in 2015 labor costs even though they haven't been paid yet.
Other Direct Labor Calculations
Once you've determined direct labor costs, you can use the figure to calculate other ratios and metrics. If you want to know direct labor cost per unit, divide total direct labor costs by the total amount of units of goods produced during the period. You could also evaluate direct labor costs as a percentage of revenue. To calculate this metric, divide direct labor costs by total revenue for the period.