Indirect Labor (Definition, classification, examples and tips)

Companies incur a wide variety of expenses in order to finance their operations, in where the salary payments of the workers who provide their services to the company are included. In business and finance, the costs of indirect labor they will depend on whether a particular worker directly assists in the production of goods.

Indirect labor costs are related to the payments of employees who do their activities that do not directly attend to the production of goods or services, such as support workers who get involved to carry out other productions of goods.

Classification of indirect labor costs

The indirect labor costs, can be differentiated as follows:

Variable indirect costs

It is the total of costs when they change in a linear proportional way or directly to production. Which means that as the units produced increase, these costs increase, for example:

• Indirect materials: These are the materials related to tools, glues, fuel and factory supplies.
• Indirect labor: Refers to the wages of workers that are not directly related to the production procedure, among them are transporters, logistics team, among others.

Fixed indirect costs

These costs are constant regardless of production levels. These are related to the expenses for reduction of insurance, machinery, tax and rent. In this classification, public services, machinery spare parts and insurance, among others, are usually applied.

Mixed indirect costs

These costs are not fixed or variable, however, they have to be kept separately in order to adequately establish the planning and control objectives. These include the factory's phone services and inspectors' schedules.

How indirect costs are determined based on direct labor

Businesses incur direct labor costs and indirect costs, both of which are critical to maintaining the factory and running the office. These add the indirect costs to the individual costs of the products, carrying out an allocation method.

This method establishes the amount of indirect expenses that have to be incorporated into the costs of each of the products. The hours of labor are the methods that are assigned to the indirect costs in the individual products and to make the calculations of the indirect cost in general.

1. Establish all indirect expenses of the annual budget

It is necessary to review the budget of the company and separate the indirect costs from the direct ones. Also, the total indirect costs for the entire year must be added to make the proper calculation of the amount that is budgeted.

2. Establish the entire budget for direct labor

The production budget should be reviewed and the various hours of labor required for each of the products identified throughout the year. For this, the hours that determine the total amount of direct labor hours for the entire year are added, in order to calculate the amount of budgeted hours.

3. Calculate indirect costs by dividing indirect costs

This is done by dividing the total budgeted costs by the total budgeted labor hours, in this way the rate per work will be obtained.

4. Add up all direct labor hours

In this case, payroll records are reviewed to determine the total monthly value of direct labor hours. Then the monthly sum is added so that the result of the total number of hours for the whole year is acquired.

5. Calculate the total indirect cost

For this calculation, the total number of direct labor hours is multiplied by the indirect rate that is already budgeted.

What is the accumulation of indirect labor costs about?

Surely there is no single way to calculate manufacturing labor overhead, which means that each department must keep its own cost control. In this sense, the existence of the creation of an account for the entire procedure is essential.

This procedure is carried out, through the sum of the costs of all departments, which determines the accumulation of costs. In this way, it will be possible to have the knowledge of the costs with greater accuracy. These department accounts are known as auxiliary accounts.

Examples of manufacturing labor costs

Having knowledge of indirect costs, some examples can be mentioned such as the following:

• The indirect materials necessary for the elaboration of a certain product are lubricants or fuels. In that case direct materials are discarded.
• Indirect labor is focused on supervisors and maintenance personnel, in the same way, employee welfare expenses can be included.
• There are also the expenses that are needed for the production indirectly, as is the case the rental of a warehouse, taxes, gas or electricity services and the acquisition of various supplies.

Manufacturing labor cost tips

It is important to consider some tips regarding manufacturing labor costs, such as the ones mentioned below:

• The total of indirect expenses is found in the ending inventory of the balance sheet, as well as in the expense of goods sold in the income statement.
• The totality of the indirect costs of the budget belongs to the totality of the total indirect costs. At the end of the year, the company must record the variance as expenses sold.
• Direct labor hours are the measures used to calculate indirect costs.
• The methodology of direct labor hours focuses on companies where indirect expenses are linked to the labor activity of direct labor workers.

Finally, if the budgeted direct labor hours or budgeted indirect costs are uncertain, so will the indirect cost rate. For this, the budget that is most updated is used and in this way its calculation is carried out.