How to Calculate Your Indirect Labor Cost
Accurately calculate your business's indirect labor costs to gain full insight into operational expenses and improve financial decision-making.
Indirect labor cost refers to the expenses associated with employees who do not directly manufacture a product or deliver a service but whose work is necessary for the overall operation of a business. These costs represent the wages and benefits paid to workers who support core production or service activities. Understanding these costs is important for businesses to gain a comprehensive view of their total operational expenses, beyond just the direct costs of creating goods or services. Accurately identifying and tracking indirect labor costs helps a business understand the true cost of maintaining its supporting infrastructure.
Identifying Indirect Labor Categories
Identifying indirect labor categories involves recognizing roles and activities that support the entire organization rather than being directly tied to specific product creation or service delivery. These employees perform functions that enable direct labor to operate efficiently and effectively. Examples include supervisory staff, administrative personnel like human resources and accounting, maintenance workers, security guards, janitorial services, and IT support staff.
The distinguishing characteristic of these roles is that their efforts are not directly traceable to an individual unit of output. For instance, an office manager’s work benefits all departments, making it impractical to assign their wages to a single product or service. Recognizing these supporting roles within a business’s structure is the first step toward quantifying their associated costs.
Gathering Relevant Cost Data
Quantifying indirect labor costs requires collecting specific financial information from various records. Businesses typically consult payroll records, employee benefit statements, and general ledger accounts related to salaries and wages. These documents provide the raw data necessary to calculate the full financial outlay for indirect labor personnel.
This data includes gross wages paid to indirect labor employees, which is their total earnings before any deductions. The employer’s share of payroll taxes is a significant component, encompassing contributions to Social Security and Medicare (FICA), which total 7.65% (6.2% for Social Security on wages up to an annual limit, and 1.45% for Medicare with no wage limit) for both the employer and employee. Additionally, employer contributions to federal unemployment taxes (FUTA), typically 0.6% on the first $7,000 of wages, and state unemployment taxes are relevant. Other data points include employer-paid health insurance premiums, contributions to retirement plans like 401(k)s, and workers’ compensation insurance premiums, which can range from $0.35 to $2.27 per $100 of payroll depending on industry and location.
Calculating Total Indirect Labor Cost
After gathering all the necessary financial data, the next step involves aggregating these components to determine the total indirect labor cost for a specific accounting period. For every indirect employee or supporting department, gross wages are added together with all associated employer-paid costs. The total of these combined expenses for all indirect labor personnel represents the comprehensive indirect labor cost for that period, whether it is a month, quarter, or year. This calculated total reflects the full financial expenditure dedicated to the workforce that supports a business’s operations without directly creating its products or services.
Allocating Indirect Labor Costs
Once the total indirect labor cost has been calculated, it is often allocated to products, services, or specific departments as part of a business’s overhead expenses. This allocation process is a fundamental aspect of cost accounting, allowing for a more complete understanding of the true cost associated with various business activities. Allocating these costs helps in making informed pricing decisions, analyzing product or service profitability, and gaining a clearer picture of resource utilization.
Common methods for allocating indirect labor costs involve using an allocation base that logically correlates with the consumption of these indirect services. Examples include direct labor hours, machine hours, direct labor cost, or sales revenue. The chosen allocation base helps distribute the total indirect labor cost proportionally, ensuring overhead is systematically assigned to the cost objects that benefit from it.