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What is Cost of Labor?

Cost of Labor

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Cost of Labor

Cost of labor is the total amount of all salaries, wages, benefits, payroll taxes and other employee-related expenses that a business incurs to employ its workforce. This cost is a substantial expense for businesses, particularly those in service or manufacturing industries where labor is a major part of creating the product or service.

There are two main categories of labor costs:

  • Direct Labor Costs: These are the costs of employees who work directly on the product being manufactured. For example, on an assembly line, the workers actually assembling the products are considered direct labor. Direct labor costs are typically considered part of the cost of goods sold (COGS).
  • Indirect Labor Costs: These are the costs of employees who support the production process but don’t work directly on the product. For example, maintenance workers, supervisors, and quality control personnel would be considered indirect labor. Indirect labor costs are typically considered part of operating expenses.

Both direct and indirect labor costs need to be carefully managed to ensure that a business is operating efficiently and profitably. Businesses often monitor labor cost as a percentage of sales or per unit of output to track efficiency and make staffing and production decisions.

Example of Cost of Labor

Let’s consider an example of a furniture manufacturing company.

Suppose the company employs carpenters, painters, and upholsterers who directly work on the furniture. Their wages, benefits, and payroll taxes all contribute to the direct labor costs.

Let’s say in a given month:

  • Carpenters’ wages: $15,000
  • Painters’ wages: $10,000
  • Upholsterers’ wages: $8,000

So, the total Direct Labor Cost for the month would be $33,000.

The company also employs supervisors, janitors, and security staff. These employees do not directly contribute to the manufacturing of furniture, but they support the overall operation. Their wages and associated costs form the indirect labor costs.

Let’s say in the same month:

  • Supervisors’ wages: $7,000
  • Janitors’ wages: $3,000
  • Security staff wages: $4,000

So, the total Indirect Labor Cost for the month would be $14,000.

In this example, the total labor cost (direct + indirect) for the month would be $47,000 ($33,000 + $14,000). The direct labor cost of $33,000 would typically be included in the cost of goods sold (COGS) on the company’s income statement, while the indirect labor cost of $14,000 would usually be classified as an operating expense.

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