What is Direct Labor Cost?

Direct labor cost is wages that are incurred in order to produce goods or provide services to customers. The total amount of direct labor cost is much more than wages paid. It also includes the payroll taxes associated with those wages, plus the cost of company-paid medical insurance, life insurance, workers' compensation insurance, any company-matched pension contributions, and other company benefits.

Direct labor costs are most commonly associated with products in a job costing environment, where the production staff is expected to record the time they spend working on various jobs. This can be a substantial chore if employees work on a multitude of different products. In the services industries, such as auditing, tax preparation, and consulting, employees are expected to track their hours by job, so their employer can bill customers based on direct labor hours worked. These are also considered to be direct labor costs. In a process costing environment, where the same product is created in very large quantities, direct labor cost is included in a general pool of conversion costs, which are then allocated equally to all of the products manufactured.

A strong case can be made in some production environments that direct labor does not really exist, and should be categorized as indirect labor, because production employees will not be sent home (and therefore not be paid) if one less unit of product is manufactured - instead, direct labor hours tend to be incurred at the same steady rate, irrespective of production volume levels, and so should be considered part of the general overhead costs associated with running a production operation.

How to Calculate Direct Labor Cost per Unit

It may be useful to determine the standard cost of the direct labor included in one unit of production. To do so, follow these steps:

Calculate the direct hourly rate, which is the total wages paid, plus payroll taxes, plus benefits for the hours worked. Then divide by the number of hours for which these costs were compiled.
Measure the number of direct labor hours required to manufacture one unit of the product in question. This is likely to be an average, since the amount of time required will vary somewhat by individual unit.
Multiply the direct hourly rate by the number of hours worked per unit to arrive at the direct labor cost per unit. Keep in mind that this outcome is based on averages, so the actual cost per individual unit produced could vary somewhat.