Further Classification of Labor Costs:
Learning Objective of the Article:
Idle time, overtime, and fringe benefits associated with direct labor workers pose particular problems in accounting for labor costs. Are these costs a part of the costs of direct labor or are they something else?
Machine beak downs, materials shortages, power failure, and the like result in idle time. The labor costs incurred during idle time are ordinarily treated as manufacturing overhead cost rather than as a direct labor cost. Most managers feel that such costs should be spread over all the production of a period rather than just the jobs that happen to be in process when breakdown or other disruptions occur.
To give an example of how the cost of idle time is handled, assume that a press operator earns $12 per hour. If the press operator is paid for a normal 40-hour workweek but is idle for 3 hours during a given week due to breakdowns, labor cost would be allocated as follows.
Direct labor $12 per hour × 37 hours)
Manufacturing overhead (idle time: $12 per hour × 3 hours)
Total cost for the week
The overtime premium paid to all factory workers (direct labor as well as indirect labor) is usually considered to be part of manufacturing overhead and is not assigned to any particular order. At first glance this may seem strange, since overtime is always spent working on some particular order. Why not charge that order for the overtime cost? The reason is that it would be considered unfair and arbitrary to charge an overtime premium against a particular order simply because the order happened to fall on the tail end of the daily production schedule.
Assume that a press operator in a plant earns $12 per hour. she is paid time and half for over time (time in excess of 40 hours a week). During a given week, she worked 45 hours and has no idle time. Her labor cost would be allocated as follows:
Direct labor ($12 × 45 hours)
Manufacturing overhead (overtime premium: $6 per hour × 5 hours)
Total Cost for the week
Observe from this computation that only the overtime premium of $6 per hour is charged to overhead account–not the entire $18 earned for each hour of overtime work ($12 regular rate × 1.5 = $18)
Labor Fringe Benefits:
Labor fringe benefits are made up of employment-related costs paid by the employer and include the cost of insurance programs, retirement plans, various supplemental unemployment benefits, and hospitalization plans. The employer also pays employer’s share of Social Security, Medicare, workers’ commission, federal employment tax, and state unemployment insurance. These costs often add up to as much as 30% to 40% of base pay.
Many firms treat all such costs as indirect labor by adding them in total to manufacturing overhead. Other firms treat the portion of fringe benefits that relates to indirect labor as additional direct labor cost. This approach is conceptually superior, since the fringe benefits provide to direct labor workers clearly represent an added cost of their service.
You may also be interested in other useful articles from “cost terms, concepts and classifications” chapter:
- Manufacturing and Non-manufacturing Costs
- Product Costs Versus Period Costs
- Cost Classifications on Financial Statement
- Cost Classifications for Predicting Cost Behavior (Variable and Fixed cost)
- Mixed or Semi variable Cost
- Cost classification for Assigning Costs to Cost Objects (Direct and Indirect Cost)
- Decision making costs – cost classification for decision making
- Quality Costs
- Further Classification of Labor Costs