Direct Vs. Indirect Labor Cost

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The accounting departments of companies that manufacture products distinguish between direct and indirect labor costs on their balance sheet. Direct labor costs are tied directly to production while indirect labor costs involve those that serve a more ancillary or support function.

Identification

By definition, direct labor costs are expenditures that directly involve the conversion of raw materials into a finished product. Contrarily, indirect labor costs are all other labor costs outside of the production process.

Types of Direct Labor Costs

Direct labor costs can include wages of factory workers, engineers, quality control, machine operators, raw materials delivery people and other production-related employees. Direct labor costs are usually considered a variable expense.

Types of Indirect Labor Costs

Janitors, maintenance workers, supply room supervisors, sales people, secretaries and marketing people are considered indirect labor employees. They support the manufacturing process but do not directly affect production.

Significance

Companies differentiate between direct and indirect labor costs so that they can measure the efficiency or productivity of their workers, which entails studying how long, on average, it takes a worker to produce one unit, according to the article "Allocation of Direct Labor" at Internalaccounting.com. Measures can then be taken to improve productivity if it falls below target levels.

Considerations

Direct labor costs are also used to figure the cost of goods sold, which is one of the key expenses for a manufacturer. Indirect expenses are generally reported by separate departments. Separating the two types of labor costs can help determine where, if any, misuse or misallocation of resources occurred.

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