Labor Cost – Definition, Types and Importance

Like materials, labor is also one of the prime inputs of production system. All manufacturing concerns require the labor for carrying out their production activities. The labor consists of workers who are essential to convert materials into finished products. The workers operate machine and perform other tasks to help convert materials into final outputs.

Labor Cost - Definition, Types and Importance

The labor can be either direct or indirect. The labor who is directly engaged in the conversion process is called direct labor and who is not is called indirect labor. The labor, however, should be properly utilized and satisfactorily paid in order to minimize labor turnover and labor cost. Unlike materials, labor is complex to deal with. Dissatisfied and discontented labor always results in high labor costs and low quality outputs. Therefore there should be proper planning, accounting and controlling of labor.

Concept and Meaning of Labor Cost

The payment made to the labor in exchange for its service is called labor cost, which constitutes a major part of the total cost of production. Labor cost is also commonly called wages. Labor cost or wages is one of the major elements of cost. Labor cost represents the expense incurred on both direct and indirect labor. However, labor cost is more than just wage as it includes the total amount of financial benefits given by the concern to all its workers and employees for their time and effort used in producing goods and services. It is, in fact, the financial compensation provided to the workers for their physical and mental contribution for converting raw materials into finished outputs. Labor cost includes monetary and non-monetary (fringe) benefits. Monetary benefits include basic wages, dearness allowance, employer’s contribution to provident find, production bonus, pension and gratuity. Fringe benefits include subsidized food, subsidized housing, subsidized education, medical facilities and holiday pay.

Types of Labor Costs

Like the labor, labor costs are also of two types such as follows;

  1. Direct Labor Cost: Direct labor cost is the amount spent by the factory for those workers involved directly in the manufacturing process. It can be measured conveniently and accurately on per unit of output basis. Direct labor cost can be identified and allocated to the specific job or process or product. It forms a part of the prime cost. The examples of direct labor costs are the payments made to the workers engaged in making table, printing a book and constructing a dam etc.
  2. Indirect Labor Cost: Indirect labor cost is the amount spent by the factory for those workers who are not directly engaged in the production process. Indirect labor cost refers to the expenses incurred in remunerating such workers who assist the direct labor to complete the manufacturing processes. It can not be identified and measured accurately on per unit of output basis. It is incurred for the benefits of a number of cost centers. It forms a part of the overhead costs. Payment made to the sweepers, watchmen, cleaners, supervisors and accounting personnel are the examples of indirect labor cost.

Importance of Labor Cost

Proper study, analysis and control of labor costs are important to all manufacturing concern because of the following reasons.

  • Labor cost is main element of cost which covers one of the major portions of the total cost of a product or job.
  • Labor cost is more difficult to control as compared to material cost due to the involvement of human element.
  • Labor cost is affected due to a change in government policy and requirement of trade union.
  • Labor cost is adversely affected due to dissatisfaction, irregularity, inefficiency, idle time, high labor turnover, lack of interest and negative attitude of the workers.
  • Labor cost is important from the fact that the direct labor cost is taken as the basis of estimating the amount of factory overheads while determining the product cost.

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