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# How Is Labor Cost Calculated

September 6, 2023
Bill Kimball

The standard cost of direct labor and the variances for the February 2020 output is computed next. This formula will give you the labor cost of a project for your crew. This number can be provided as a standard base before adding the costs of materials and other factors known to change on a project-by-project basis. Cost accounting is a form of managerial accounting that aims to capture a company’s total cost of production by assessing its variable and fixed costs. One of the most important tips for decreasing your labor expenses is to accurately track employee hours. Mistakes in time tracking can have serious and costly consequences for your business. If you are looking for a simplified method to determine your construction labor cost, you’re in the right place.

Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Keeping your labor costs under control is a large part of the expense management for your business. This does not mean reducing employee wages and cutting corners when it comes to the extra labor costs. However, it does entail being observant and setting clear rules regarding attendance, overtime and logging of worked hours.

## Cost Of Labor Vs Cost Of Living

The variance is obtained by calculating the difference between the direct labor standard cost per unit and the actual direct labor cost per unit. If the actual direct labor cost is lower, it costs lower to produce one unit of a product than the standard direct labor rate, and therefore, it is favorable. The direct labor price variance is the difference between the actual direct labor price and the direct labor standard price. You have a favorable price variance when your actual direct labor price is less than the standard price, meaning it cost you less to produce the units than you expected. An unfavorable standard rate variance is when the actual direct labor price is more than the standard price. This means that your direct labor costs were higher than the standard price. Whether the variance is favorable or unfavorable, you want to investigate the reasons behind an unusually large price variance.

For example, in the hospitality sector, tipping is often encouraged, allowing businesses to reduce their cost of labor. Then subtract the total by the 2,080 hours they’re able to work each year. This will give you the number of hours they are actually working annually. Following this example, your base rate is going to be \$80 per hour. Think about the size of your average crew while determining your base rate.

Let’s say, for instance; you have three men working on a project that will last 6 weeks. They are working 8-hour shifts, which will translate into a 40 hour work week. The person can work 2,080 hours each year, and they can be out for 15 days due to holidays and the sick/vacation days they are given. Costs can become a bit more confusing when working with a crew or an unforeseen problem arises. It’s never fun to admit to a client when you’ve made a mistake that can cost them more money. Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes.

## Keep Track Of Labor Costs For Your Business

This information is used to determine the profit derived from a sale, which assumes the inclusion of all applicable costs. This cost of labor is also used to calculate the cost of ending inventory and the cost of goods sold under a standard costing system. The labor burden is the cost of each employee outside of their hourly wage. Included in calculating the labor burden are the employees’ benefits packages paid by the company. The formula for finding each employees’ labor burden is fairly simple.

Next, do the same calculations for each employee on your crew to determine the base rate for the entire team working on the project. Your records should show you the yearly costs of having an employee.

For example, one employee completes one job during an eight-hour shift. Each employee gets 30 minutes of break time and 30 minutes for lunch, or one hour total. The standard direct labor time to complete one job is eight hours minus one hour, or seven hours. While the cost of labor refers to the sum of all wages paid to employees, it should not be confused with the cost of living. The cost of living is the cost needed to maintain a certain standard of living by a consumer in a specific geographic location. These rates can sometimes be much higher than the cost of labor, especially in highly metropolitan areas.

You have to account for labor, materials, and equipment, to name a few. Kirsten Rohrs Schmitt is an accomplished professional editor, writer, proofreader, and fact-checker. She has expertise in finance, investing, real estate, and world history.

When you determine your labor cost percentage, you can make a deeper analysis of your employee expenses. That’s how you can figure out if you need to reduce them to increase your overall profit margins. You have to keep tabs on your labor expenses and to constantly compare them to your revenue, so that employee costs don’t harm your bottom-line.

## Chapter 8: Standard Cost Systems

Any difference between the standard and actual rates results in a labor rate variance. IN CONTRAST, what if this company runs ‘lean and mean’, and the cost of labor is actually \$30/hour average, rather than the industry average of \$35? Whether you’re running a restaurant, a construction company, or another small business with employees, labor costs are some of the biggest expenses you’ll need to cover. The variance is unfavorable because more materials were used than the standard quantity allowed to complete the job.

• Time and cost not assigned to jobs for administration, company meetings, and “no work available”.
• The amount by which actual cost differs from standard cost is called a variance.
• The labor costs for both products are incorrect, and the sale prices of the two goods will not reflect their true cost.
• You cannot do much about reducing most of the additional labor costs, such as payroll taxes and benefits.
• The hourly rate is obtained by dividing the value of fringe benefits and payroll taxes by the number of hours worked in the specific payroll period.
• In addition to what the company pays the employees, it must consider costs to retain employees, such as payroll tax contributions, insurance premiums, and benefits costs.
• In many plants, the standard is based on rates established in collective bargaining agreements that define hourly wages, piece rates and bonus differentials.

Here again, it follows that the actual labor cost may differ from standard labor cost because of the wages paid for labor, the quantity of labor used, or both. Thus, two labor variances exist—a rate variance and an efficiency variance. Your direct labor standard price includes the basic hourly wage and the business portion of the Medicare and Social Security taxes you pay for each employee. The cost of employee fringe benefits such as vacation pay, holiday pay and medical leave are part of the direct labor standard price.

## What Figures Do You Use To Find Direct Labor When It Is Missing From A Formula?

But if the quality of materials used varies with price, the accounting and purchasing departments may perform special studies to find the right quality. A favorable labor rate variance suggests cost efficient employment of direct labor by the organization. Now, let’s see how knowing your base rates can help determine the construction labor cost.

The standard materials cost of any product is simply the standard quantity of materials that should be used multiplied by the standard price that should be paid for those materials. Actual costs may differ from standard costs for materials because the price paid for the materials and/or the quantity of materials used varied from the standard amounts management had set. These two factors are accounted for by isolating two variances for materials—a price variance and a usage variance.

A firm can easily increase or decrease variable labor cost by increasing or decreasing production. Fixed labor costs can include set fees for long term service contracts. A firm might have a contract with an outside vendor to perform repair and maintenance on the equipment, and that is a fixed cost. Determine whether a variance is favorable or unfavorable by reliance on reason or logic. If more materials were used than the standard quantity, or if a price greater than the standard price was paid, the variance is unfavorable.

In both cases, there may be a number of standard labor rates, each one based on the general skill sets of the employees presumed to be engaged in the related work. If there is only a single standard labor rate, it should be based on a weighted average of the fully burdened labor costs of those employees most likely to be engaged in the related work. Labor rate variance The labor rate varianceoccurs when the average rate of pay is higher or lower than the standard cost to produce a product or complete a process. The labor rate variance is similar to the materials price variance. The direct labor standard time is based on the actual amount of time it takes for one employee to complete one job. You track the actual time by having your employees keep a log of when they start and stop their job activities. The time spent on breaks, lunch or personal time is deducted from the work day.

## How To Figure Out Direct Labor Cost Per Unit

Labor efficiency variance Usually, the company’s engineering department sets the standard amount of direct labor-hours needed to complete a product. Engineers may base the direct labor-hours standard on time and motion studies or on bargaining with the employees’ union. The labor efficiency variance occurs when employees use more or less than the standard amount of direct labor-hours to produce a product or complete a process. The labor efficiency variance is similar to the materials usage variance. Many companies prepare a single standard rate for all employees in a department. This standard rate reflect the expected “mix” of workers, even though the actual wage rates may very somewhat from individual to individual due to differing skills or seniority.

## So, Which Employee Labor Rate Should You Use To Charge For Your Employees Time?

Kirsten is also the founder and director of Your Best Edit; find her on LinkedIn and Facebook. Time and cost not assigned to jobs for administration, company meetings, and “no work available”. Keeping these formulas on hand won’t just help you deliver estimates speedily. Instead, it will help you develop a more accurate way of scheduling and meeting your financial goals.

The labor rate pricing is determined by adding the hourly rates of the employees who will be working on a single project. Since indirect labor costs can be difficult to allocate to the correct product or service, XYZ Furniture may underallocate labor costs to one product and overallocate labor costs to another. This situation is referred to as undercosting and overcosting, and it can lead to incorrect product pricing. To assure fairness in rates paid for each operation performed, job rating has become a recognized procedure in industry. When a rate is revised or a change is authorized temporarily, it must be reported promptly to the payroll department to avoid delays, incorrect pay, and faulty reporting.

If you pay for all or part of your employees’ health insurance, accident insurance or life insurance, you include those amounts in with the direct labor standard price. You can include the full amount or use a percentage of the fringe benefits costs.