The indirect cost of labor refers to amounts paid for employees that support the commodity but aren't directly involved in making it.
Understanding the cost of labor helps companies price products, and without an understanding of direct and indirect costs companies may find it challenging to arrive at the right cost of products.
As a result, a deep understanding of labor cost and how to use it is beneficial for the economy. Cost of labor can be further broken down into fixed and variable costs:. Related: Learn About Being an Estimator. Direct labor costs refer to costs that are derived directly from supply chain employees involved in the production.
This could be assemblers, manufacturers, heavy machinery users, fabricators, craftsmen and artisans, delivery drivers and other logistical employees essential for getting goods into consumer's hands. 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. Yet another option for direct labor costs is the payment made to a logistics company responsible for delivering goods across the country.
In each case, the employee whose salary and benefits are being accounted for plays an essential role in producing a product and distributing it through the supply chain. Indirect labor refers to any employee whose role is not essential to the direct production of a product.
These employees still play important roles like administration, supervisory roles and finance but they aren't involved in the supply chain. An example of indirect labor costs is the salaries of employees in the human resources department. Another example of indirect labor costs would be the salary, benefits and bonuses of a chief financial officer of a Fortune company that manufactures auto parts.
Since this employee is not directly involved in the production of auto parts, their salary represents an indirect cost.
All organizations have to pay certain expenses just to stay in business, regardless of how many sales they make. Examples of so-called fixed expenses include rent, electricity and property taxes. Other costs are variable, which means they go up or down with the volume of sales or production.
Labor can be either a fixed or variable cost, depending on how you pay your workers. A fixed cost is one that stays the same every month regardless of how much you're selling. Examples include your rent, utilities, accounting expenses and annual staff salaries. Salaries are classified as fixed costs when they do not vary with the number of hours a person works, or with the output rolling off your production line.
The amount is fixed. Fixed labor costs remain the same despite fluctuations in a company's production output, according to the Small Business Administration SBA. Owners and employees who earn a fixed salary regardless of total hours worked are obvious examples of fixed labor costs. One benefit of fixed labor costs is that business owners avoid paying overtime to managerial and supervisory staff.
On the other hand, it's usually challenging to lower fixed labor costs without compromising the efficiency or efficacy of business operations. Direct expenses are costs that are connected to a specific cost object, such as raw materials used to develop a specific product or software implemented to quality control a consumer good or service.
The majority of direct costs are labor and direct materials. According to the Financial Accounting Standards Board FASB , which is the authority on nongovernmental generally accepted accounting principles GAAP , variable and fixed labor costs can be categorized as direct or indirect.
Some examples of direct labor include quality control engineers, assembly line workers, production managers and delivery truck drivers. Unlike indirect labor, direct labor encompasses costs that are allocated to each consumer good or service produced by a company.
This includes housing, food, transportation, entertainment, etc. These rates can sometimes be much higher than the cost of labor, especially in highly metropolitan areas. For example, the cost of living is higher in New York City than in a suburban city. Demand for housing and food is higher, which means higher prices for consumers. Financial Ratios. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.
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Popular Courses. What Is the Cost of Labor? Key Takeaways Costs of labor can be categorized into two main categories, direct production and indirect non-production cost of labor.
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