## Labor Cost

Subject: Principles of Accounting

#### Overview

This note is about the Accounting for labor which includes the introduction and meaning of labor. Labor cost or wages is a main element of cost. It includes two types of labor cost like Direct labor cost and Indirect labor cost. It includes importance of labor cost like use direct labor cost as the basis for increasing the efficiency of workers.

### INTRODUCTION

Every organization consists of people working in it. The success of an organization depends on a large extent upon the quality of person working in it. It is very difficult task for the management to deal with human beings, who are different in nature and hence, it is difficult to control. Management tries to make the best use of available human resources and reduce the total labor cost by increasing their productivity.

On the other hand, workers always demand a high rate of wages. Due to these contradicting interests, the task of labor management has become difficult. Management uses various methods of payment of wage rate to keep the labor cost under balance and also to account for it properly so as to calculate labor cost of production.

### Meaning of Labor Cost

Labor cost or wages is a main element of cost. Labor cost means to any remuneration paid to the employees by the organization in the form of wages, salary, bonus, allowances, etc. for their time and effort used in production of goods or services. Any financial compensation, given to the employees working in the organization or company to achieve the common goal is called labor cost. In other words, it is the remuneration paid to the workers or employees for their mental and physical contribution towards the organization.

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The Institute of Cost and Management Accounts of U.K.has defined labor cost as “the cost of remuneration of the employees of an undertaking”.

A significant expenditure has to be made to keep the employees in the organization and also to keep them satisfied so that they give their best. The labor cost can be analyzed into the following:

• Monetary benefits: Salaries and wages, other allowances or dearness, production incentive or bonus, overtime allowances, employers contribution to provident fund, old age pension, payment of the insurance scheme, retirement gratuity, salary in lieu of leave, profit-linked bonus, etc.

• Non-monetary benefits ( Fringe benefits): Subsidized food and housing, subsidized or free transport, subsidized or free clothing, subsidized or free education to employees children medical and recreational facilities, etc.

### Types of Labor Cost

The labor cost can broadly be classified into:

• Direct Labor Cost

Direct labor cost is that portion of wages and salary which can be determined and charged to a single costing unit. It is the remuneration of the employees who are involved with the manufacturing operations or the conversion of raw materials into finished products. The most important characteristic of direct labor costs is that it can be identified with and allocated to cost units or cost centers.

This cost is incurred for converting raw materials into finished goods. The example of direct labor cost is wages paid to workmen who are put on definite jobs or products in the factory. Direct labor cost is also known as “Direct Wages”, “Productive Wages”, “Manufacturing Wages”, “Operating Wages” or “Factory Wages”. Direct labor cost is a part of the prime cost.

• Indirect Labor Cost

Indirect labor cost is the remuneration of the employees who are not involved with manufacturing operations. The direct employees are not directly associated with the modification process but assist in the process by way of supervision, maintenance, transportation of materials, material handling, etc. Their work benefits all the items being produced and cannot specifically identify the individual products.

These costs will be an apportioned to different cost centers on an equitable basis and absorbed into product cost by forcing the overhead absorption rate. Wages or salaries paid to the supervisor, clerical staff, storekeeper, foremen, etc, are the examples of indirect labor cost. Indirect labor cost is also known as “Unproductive Wages”, “Indirect Wages”, and it is treated as part of “Overhead”.

Different between Direct Labor Cost and Indirect Cost:

 Bases of Differences Direct Labor Cost Indirect Labor Cost Involvement with production Direct labor cost is that cost which is directly involved in the production. Indirect labor cost is that cost which is not directly involved in the production. The volume of production Direct labor cost depends on upon the volume of production. Indirect labor cost does not depend on upon the volume of production. Separation It can be separated in cost, cost center, or unit cost. It cannot be separated in unit cost. Payment It is a direct expenditure. It is an indirect expenditure. Use It is used to convert raw materials into finished goods. It is used in the production process. Part It is a part of the prime cost. It is a part of overhead.

### Importance of Labor Cost

Accumulation, analysis and proper control over labor costs are most important to each and every manufacturing organization for the fulfillment of given purpose:

• To use direct labor cost as the basis for increasing the efficiency of workers.
• To identify direct labor cost with the product, job or process for ascertaining the cost of production as accurately as possible.
• To use direct labor cost as the basis for absorption of overhead, if desired.
• To use direct labor as a basis for comparison with past labor cost and for substitution purpose.
• To determine the amount of indirect labor cost which should be treated as overhead.
• To reduce the labor turnover.

#### Labor Cost Control and Its Need

Labor costs may become unduly high due to the inefficiency of labor, wastage of material due to improper supervision, idle time and unusual overtime work, an inclusion of dumpy names in the payrolls and other related factors. Inefficient use of labor not only increases the cost of production but also adversely effects the quality of products. The primary objective of the management is to utilize the labor as economically as possible. Therefore, it is necessary for the management to device a proper system of labor cost control.

Control over labor costs requires proper employment and efficient utilization of labor force. These factors affect the cost and quality of the products of any industrial undertaking and ultimately its profitability. Labor cost control involves the employment of efficiency workers, proper training of workers, proper time keeping and time booking and proper accounting for the wages paid to them.

References:

Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu

Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu

Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu

##### Things to remember
1.  The success of an organization depends on a large extent upon the quality of person working in it.
2. The Institute of Cost and Management Accounts of U.K.has defined labor cost as “the cost of remuneration of the employees of an undertaking”.
3. Control over labor costs requires proper employment and efficient utilization of labor force.
4. .A significant expenditure has to be made to keep the employees in the organization and also to keep them satisfied so that they give their best.
5. Indirect labor cost is the remuneration of the employees who are not involved with manufacturing operations
• It includes every relationship which established among the people.
• There can be more than one community in a society. Community smaller than society.
• It is a network of social relationships which cannot see or touched.
• common interests and common objectives are not necessary for society.