Direct Cost vs Indirect Cost
Direct Labor Variance Formulas
Absorption Cost Accounting
Direct Material Variance Formulas
In accounting, direct labor (DL) costs are the costs associated with paying workers to make a product or provide a service. The workers must be clearly involved in producing the product or providing the service. Direct labor costs are one of the costs associated with producing a product or providing a service. Furthermore, direct labor costs are in contrast to indirect labor costs. Indirect labor costs are costs associated with workers who are necessary, but they are not directly involved with making the product or providing the service.
Examples of direct labor costs include the following:
- In a manufacturing setting, wages paid to workers in an assembly line
- In a service setting, wages paid to workers in the kitchen of a restaurant
Direct Labor and Overhead Allocation
Sometimes it may be appropriate to use direct labor as a cost driver to allocate indirect costs to a production process.
Indirect costs, such as overhead costs, are not directly traceable to the final product; however they are necessary for the production of the process. As a result, they must be incorporated in the overall cost of the product. In addition, allocate indirect costs to the final product by way of a cost driver.
In production, processes in which direct labor is an appropriate cost driver, allocate indirect costs to the cost of units of output via DL hours. Then, allocate indirect costs to the units of output using a cost driver rate. For example, it could be $2 dollars per hour of direct labor, or $0.40 per hour of direct labor, depending on the specifics of the production process.
Direct labor is a typical cost driver for allocating indirect costs to units of output from a production process. But as production processes have become more automated over time, using DL is no longer as common as it once was. As a result, other cost drivers are frequently used to allocate indirect costs in a production process or in providing services to customers.
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Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.