What Figures Do You Use to Find Direct Labor When It Is Missing From a Formula?

A business that produces goods or services must develop and maintain accurate estimates of the cost of production. Direct labor, meaning toe work required to actually make a product, is a critical component of manufacturing costs. Without knowing the direct labor cost, a business may overprice its goods and lose customers to competitors. Underestimating direct labor may lead to setting prices too low to allow for covering expenses and making an adequate profit. If the figures for direct labor are missing from a formula such as one used to set prices, it's important to know how to find the necessary information.

Direct Labor Cost Basics

Some of the workers in a factory perform tasks that are directly linked to the manufacturing process. A machine operator is one example of this direct labor. Other factory floor employees are considered indirect labor because their jobs are not immediately tied to making the product. Equipment maintenance technicians and security guards fall into this category. The difference is crucial because only direct labor is counted as part of the cost of manufacturing a good. Direct labor includes wages plus employer-paid payroll taxes like Social Security and Medicare tax. It also includes other benefits such as worker's compensation and unemployment insurance, health insurance and contributions to pension or retirement plans.

Direct labor is one component of the total manufacturing cost of a product, along with direct materials and manufacturing overhead. Direct materials means the materials actually used to make a product. Manufacturing overhead refers to other expenses necessary for the item to be produced such as factory rent and depreciation. That is, manufacturing overhead is the indirect costs of production, including indirect labor. Direct labor is considered a variable cost because it changes depending on the number of units produced. Indirect labor is classed as a fixed cost since it tens to stay constant even when factory output changes. The cost of security, for example, is likely to stay constant even if the factory shuts down temporarily.

Figures Required to Calculate Direct Labor

You must determine two figures to calculate direct labor cost: a standard or average rate for one hour of direct labor and the number of hours required to manufacture one unit. For production planning, budgeting and product pricing purposes, these figures are estimates based on expected results under normal circumstances. To create a standard hourly rate, start with the wages paid to factory workers who are considered direct labor. Add employer-paid payroll taxes, insurance premiums for unemployment and workers' compensation and any other benefits provided by the company.

Suppose XYZ Widgets employs a direct labor workforce of 10 people, who work 40 hours per week, and they earn an average of $18 per hour. Total wages are equal to 40 hours multiplied by $18 and then multiplied by 10. This works out to $7,200 per week. Additional payroll taxes and benefits total $1,800, which gives a total direct labor weekly payroll expenditure of $9,000. Ten workers normally work 400 hours in a week, so the standard or average cost of one hour of direct labor equals $9,000 divided by 400, or $22.50.

To calculate the time required to complete one unit, divide the total direct labor hours by the number of units that the workers can be expected to complete. Suppose XYZ Widgets production records show 10 employees who are working a total of 400 hours per week can manufacture 500 units. Divide 400 hours by 500. The time required per unit equals 0.8 hours.

Calculate Direct Labor Cost per Unit

The labor cost formula to calculate direct labor cost per unit is the standard cost of one hour of labor multiplied by the number of hours needed to produce one unit. At XYZ Widgets, one direct labor hour costs $22.50 and 0.8 hours are required to manufacture each widget. Multiply $22.50 by 0.8 and you have a per-unit, direct labor cost of $18.00.