Often in business management and finance, labor costs are divided into direct labor costs and indirect labor costs, depending on whether the worker contributes directly to the manufacture of products or, on the contrary, does not it does.
Therefore, indirect labor are employees such as accountants, supervisors, security guards, among others, who do not directly produce goods or services, but who make their production possible or more efficient.
Indirect labor costs are not easily identifiable with a specific task or work order. For this reason, these expenses are called indirect costs and are charged to the general expense accounts.
Characteristics
Indirect labor cost describes the wages paid to employees who perform activities that do not directly support the production of goods, such as support workers, who help others produce goods.
A company can use cleaning workers to keep its facilities clean. You can also employ security guards to protect the facilities and managers to supervise the production staff. All these personnel are included in indirect labor, because they do not actually produce any products.
Indirect labor cost - like other indirect costs - should be treated as overhead and expensed in the period incurred, or allocated to a cost object through a predetermined overhead rate.
The cost of the different types of indirect labor is charged to factory overheads, and from there to the production units manufactured during the reported period.
This means that the cost of indirect labor related to the production process ultimately ends up either in ending inventory or in the cost of merchandise sold.
Gross profit and cost of merchandise sold
Gross profit is an indicator of the amount of money a company receives during a given period of time. Gross profit equals the company's total sales minus the company's cost of merchandise sold.
The cost of merchandise sold contains all costs directly related to production, such as the cost of raw materials and parts used to produce the goods, and the cost of direct labor.
Net profit
Net profit is the total amount of sales a company makes during a specific period of time, subtracting its total expenses.
Net profit takes into account both the cost of the merchandise sold and all other costs. Indirect labor costs, insurance and taxes are included.
A company with high indirect labor costs could have a high gross profit. However, your net profit may be low or even negative. If a company has a negative net profit, it means that during the period in question it lost money.
One way that companies can try to increase their net profit is by reducing indirect labor costs by laying off support workers.
Examples
Some labor costs may be incurred during the production process or when rendering services. They can still be considered indirect, because they are either not easily applicable or cannot be properly assigned to a product.
Indirect labor in production
It is not always easy to distinguish between direct and indirect labor costs. Examples of indirect labor costs include, for example, the cost of an employee supervising machines in an automated production process.
The employee must supervise the machinery and personnel in the production process, but since the employee is not actually involved in that production process, the relevant labor cost is considered as indirect labor cost and is treated as such.
Indirect labor cannot be assigned to a specific product. If a janitor cleans the work area for an assembly line worker, the janitor's job does not actually create a product. It also cannot be assigned to a product.
The janitor helps the company produce products, but his job is not associated with any product. That is why the janitor's job is considered an indirect job: He indirectly helps the company to produce products.
Overtime
Another example of indirect labor cost is overtime. Sometimes it is appropriate to consider overtime pay as direct labor; other times it is appropriate to regard it as indirect labor.
For example, there are cases of random overtime payments, in which an employee working in the production process is working overtime not at will, but because it is the rush job or it is a particularly strenuous job that requires additional time.
In this case, the payment of overtime can be considered as a general expense and treated in this way.
Other examples
- Shopping Staff.
- Material warehouse staff.
- Planning staff.
- Quality control personnel.
- If any item is manufactured, then the receptionist, hiring manager, marketing manager, and accountant are indirect labor. The cost of these positions cannot be carried over to production activities; therefore, it is charged to expenses as they are incurred.
The cost of both types of indirect labor can be fully borne by the cost of allowances and payroll taxes for financial analysis or cost accounting purposes, as these additional costs are closely related to labor positions hint.
