What Gets Included as Direct Labor?

Direct labor refers to wages you pay workers for manufacturing a certain product or fulfilling a specific service. It is a direct amount that pertains to only the people who actually make the product or perform the service. The work must be exactly related to a specific job for it to be called direct labor. If you cannot connect an employee’s work to a particular work order or service or if she does not directly manufacture the product, then her labor is indirect instead of direct.

An example of direct labor would be workers in a construction company who actually build buildings. Factory workers who make products and retail store workers who serve customers engage in direct labor as well. However, workers who support the process, such as human resources, accounting and other administrative employees, engage in indirect labor. Direct cost is not the same as direct labor. Direct cost relates to the amount spent on making the final product; this includes both direct labor and direct material costs.

Budgeting is essential to direct labor, because it lets you know whether enough hours are available to satisfy production requirements. A direct labor budget consists of the projected production units and the number of direct labor hours needed to make each unit. To arrive at the total direct labor hours, multiply the projected units by the budgeted hours per unit. Then multiply the total direct labor hours by the employee’s cost per hour to get your total budgeted amount.

Direct labor cost is the part of your gross payroll that goes toward employees who perform the work. It includes all forms of wages paid, such as salaries and regular and overtime wages. Additional forms of payments, such as bonuses and commissions, also are direct labor costs. In addition, factor in benefits and expenses that are linked to the staff needed for direct labor. Benefits and expenses include paid vacation, sick, personal and bereavement days and holidays, company-sponsored vehicles and cell phones, uniforms, health insurance, 401(k) match, seminars, training, awards, prizes and employer-paid entertainment, meals and snacks.

Your mandatory obligations as an employer also count toward your direct labor cost. This includes your portion of Social Security and Medicare taxes, federal and state unemployment insurance, and workers’ compensation and state disability insurance, if applicable. Depending on your state, you might be required to pay local payroll taxes and a job training tax.

To determine the true cost of a direct labor employee, determine her total work hours for the year. Then multiply her hourly rate by her annual work hours to get her yearly hourly wages. Add all of your annual hidden costs together, including benefits and your portion of taxes. When you add all of your hidden costs to the employee’s annual wages, the result is likely much higher than the gross wages she receives each payday.