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Indirect Labor

See Also:
Indirect Materials
Accounts Payable
Audit Committee
Managed Sales And Use Tax Audit Programs
Carried Interests

Indirect Labor Definition

In accounting, indirect labor is a category of indirect cost. It refers to labor costs incurred during a service or production process, but are not directly traceable to a cost object. Consider them overhead costs and treat them accordingly.

Indirect Labor Example

It is not always easy to distinguish between direct and indirect labor costs. Some labor costs may be incurred during the production process or while providing services, but still may be considered indirect because they are not readily applicable or not conveniently traceable.

Examples of indirect labor costs include, for example, the cost of an employee overseeing machines in an automated production process. The employee must oversee the machinery and equipment in the production process, but because the employee is not actually engaged in the production process the relevant labor costs are considered indirect labor costs and treated as such.

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Another example of indirect labor costs is overtime. Sometimes it is appropriate to consider overtime wages direct labor and sometimes it is appropriate to consider overtime indirect labor.

When overtime wages are incurred by chance – it just so happens the employee working on the production process is working overtime – as opposed to by necessity – the job was a rush-job or a particularly strenuous job that required extra work – then the overtime wages may be considered overhead and treated accordingly.

Treatment

Treat indirect labor costs, like other indirect costs, as overhead and either expensed in the period in which they are incurred, or allocated to a cost object via a predetermined overhead rate.

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Labor Costs

See Also:
Absorption vs Variable Costing
Agency Costs
Operating Capital
Replacement Costs

Labor Costs Definition

The labor costs definition is the total cost of all labor used in a business. It is one of the most substantial operating costs. These are particularly important in any business which experience heavy human resource labor costs: construction, manufacturing, and other industries which have partially or non-automated operations. These costs include 2 main subcategories. The direct labor costs definition is summarized as the cost of labor which is used directly to make products. Meanwhile, the indirect labor costs definition is simply explained as the cost of labor which is used to support or make direct labor more efficient.

Labor Costs Explanation

These costs are explained by many as the most important cost a company will face, is a key factor in almost any business. This is due to the fact that employee turnover is one of the main factors which causes a business to fail. To begin, it is in the best interest of any owner that unit labor costs and inflation are minimized to maximize profits.

The importance of labor costs does not stop here. They are a variable cost. As such, they must also occur in a predictable cycle to avoid cash flow problems. If a firm is seasonal and requires additional labor at peak times, business controllers must have the cash on hand to afford this increase in cost. If a business plans properly it will avoid many cash issues associated with the cost of labor.

Labor Costs Formula

A single formula will not serve the many different needs associated. Despite this, a common and simple formula is included below:

Labor Costs = (total sales x labor %) / average hourly rate of labor

Labor Costs Calculation

To perform a simple labor costs calculation follow the process outlined below:

If:
Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

Labor Costs Example

For example, Leann is the owner of a clothing store in the largest mall in her city. Leann, a fashion aficionado from birth, knows the popular styles better than any designer in Milan. She works diligently to make sure her store stays in pace with the trends of today as well as the future.

Leann is gearing up for her peak season. Additionally, she is concerned because her off-season sales have slumped slightly. She sees the new season as a great opportunity to move inventory and regain the ground. That is, if she has enough cash to get by.

Leann will need to increase hours for sales and backroom staff during these peak times. To balance that, she will also have to make sure she can pay for these employees. The slump in her off-peak season has made Leann plan more for the future. She now wants to calculate cost of labor for her peak period to make sure she can afford the cash needed to get by.

Example Calculation

Leann performs this simple calculation to find her cost of labor:

If:
Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Then:
Labor Costs = (total sales x labor%) / average hourly rate of labor
Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

For Leann’s retail business cost of labor total $15,000 for the period she is studying. This is more than she expected and can afford. Luckily, Leann has excellent credit. Leann decides to apply for a small business loan to help her company survive the first month of peak demand. From here she will make the cash necessary to continue.

Leann also decides to pay more attention to her company finances. She was not surprised by this situation, but still wants to be able to predict the problems that her business will face better. Her drive and insight will achieve this and many future goals.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

Labor Costs, Labor Costs Definition

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Labor Costs, Labor Costs Definition

 

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Direct Labor

See Also:
Direct Cost vs Indirect Cost
Cost Driver
Direct Materials
Direct Labor Variance Formulas
Absorption Cost Accounting
Direct Material Variance Formulas

Direct Labor Definition

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.

Overhead Allocation

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.

Direct Labor

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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direct labor

Source:

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

 

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Construction Accounting

See Also:
Progress Billing for a General Contractor
Cash Flow Statement
How to Select Your Commercial Insurance Broker
Chief Financial Officer (CFO)
Financial Ratios

Construction Accounting Definition

Construction accounting, a type of project accounting, is the method for financially tracking the progress of a construction job. This is essential for bidding, request-for-proposals, project management, invoicing, construction retention payments, and more.

The process of construction accounting management involves monitoring both costs and revenues. Costs fall into 3 main categories: Direct (Direct Labor, Direct Materials, etc.); Indirect (Indirect Labor, Indirect Materials, etc.); and selling, general, and administrative.

To account for revenue, compare the expected project value to the approximate percentage of completion of the project. Over time, you will receive cash with completion invoices. A final payment made upon satisfactory completion of the job. The construction retainer is the final payment because it retains the contractor until that the project is completed.

Construction accounting and financial management involves monitoring draw, progress billing, work-in-progress, and a slew of construction accounting methods which range from GAAP compliant to industry-specific. Generally, the industry has accepted a series of unique methods of financial reporting that are not present anywhere else. These aid in construction accounting and taxation.

Construction Retention Definition

Construction retainage is the final amount of payment kept, by the customer, to ensure satisfactory completion of a project. In both residential and commercial construction, construction retainage is also referred to retention money. Although it is extremely common to the construction world, you can use this method of quality control in other places.

In the world of construction, retention accounting occurs in a similar method as above. Projects are paid with increasing completion until finished. Then, the customer will examine the project, with the project manager, to ensure that it meets their needs. The customer makes the final payment once this is agree upon. To contractors and other workers in construction, this is when retention release has occurred.

Laws exist to protect the investment of the customer as well as the contractor. Laws vary from state to state. An attorney that is experienced with construction retention laws should deal with any discrepancies. In the event of unacceptable or negligent construction, recovery of the retainage is a possibility. Maintain every document and record for each client and each project so that in the event of a disagreement, you will have support to your case.

Construction Accounting Example

The founder of Cabinetco, a custom cabinetry builder, is Maggie. Her projects, pieces of art in their own right, have continuously pleased customers. Maggie, over time, has become well versed in the process of accounting for her projects.

Maggie begins her projects with a Request-for-proposal, or RFP. Her records of past projects allow her to closely estimate the total cost of each new project. Upon this foundation Maggie makes a bid for the estimated cost of each project. In her experience, customers are always pleased when they pay less than the estimate. Therefore, Maggie makes sure to present customers an estimated cost which will be less than her billed price. She does this with a keen eye so as to ensure consistent profitability on each project.

Maggie knows that her bid price does not drive her business: customers do. She has made great efforts to present excellent work and has created happy customers. Word-of-mouth is her most effective marketing message. This leverage allows her to negotiate the lowest retainage payment possible. Maggie knows the importance of cash flow in the survival of her business.

How To Account on Long Projects

Once Maggie has confirmed her bid with a customer she begins building. She then orders the perfect materials and has a trusted team to subcontract her building. Her role in this process is as a project manager. Her ability to control quality drives word-of-mouth recommendations to Cabinetco.

On long projects Maggie sends regular invoices. These state the percentage of completion on the project, the payment due for that level of completion, expected date to the next invoice or benchmark, and other details.

Maggie, finally, presents the project to the customer. She knows that every time she sees a happy face she is retaining customers as well as defining her brand. She then sets a date for final completion and invoices for her project retainage.

Maggie has cracked the code to success in her business. To her, it is about accountability, over-delivering, and project management.


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