What is the Cost of Labor?

It is an amount paid by employers towards the workers’ wages, benefits, and payroll taxes. It can be classified into direct costsDirect CostsDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more and indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more. Direct costs are such costs that can be directly allocated to the finished goods. In contrast, indirect costs are such costs that cannot be directly associated with the overall production costs of the finished goods.

Formula to Calculate

The cost of labor is broken into direct and indirect costs. So, the formula that can be used for calculation is as follows:

Where,

  • Total direct cost is the total cost of the company paid to its employees for work that relates directly to the manufacturing of products or the provision of services.Total indirect cost is the total cost of the company paid to its employees for work that does not relate directly to the manufacturing of product or provision of services like amount paid to support labor etc.

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Examples of the Cost of labor

ABC Company manufactures dolls and sells them in the market. During a period, ABC Company paid wages of $100,000 to the assembly workers for making dolls in the factory and $15,000 to the security guards at the manufacturing plant. Calculate the cost of labor of the company using the information given.

Solution:

Step 1: Calculate Direct Labor Expense

From the information given, the wages of $100,000 paid to the assembly workers for making dolls in the factory are related directly with the manufacturing of the product of the company, and it is the company’s direct labor cost.

So for the period total direct labor expense = $100,000

Step 2: Calculate Indirect Labor Expense

From the information given, the wages of $15,000 paid to the security guards at the manufacturing plant are related not directly with the manufacturing of the product of the company, and it is the company’s indirect labor cost.

So for the period total indirect labor expense = $15,000

Step 3: Calculate

  • = $100,000 + $15,000= $115,000

Importance

Cost of labor is a highly important aspect for employers as it helps them in the following matters:

  • Management of Costs: It helps employers in managing costs. Employers can easily identify workers that are not performing as per the expectations and requirements. In this way, they can go for cost-cutting as and whenever required and got rid of undeserving and under-performing workers.Outsourcing: For estimating the updated cost structureCost StructureCost Structure refers to those costs or expenses (fixed as well as variable costs) which businesses will incur or will have to incur to produce the desired objective of the business; such costs include the cost of purchasing the raw material to the cost of packaging the finished products.read more of a business, management must understand all its labor costs before outsourcing any sort of activities to a seller or a supplier.

Difference Between Cost of Labor and Cost of Living

Both differ from each other on different parameters. The differences are given below:

  • Meaning: Cost of living can be defined as the costs that are necessarily borne by a customer to maintain a standard of living in a particular geographical area. On the other hand, the cost of labor can be defined as the costs that are borne by an employer in the form of salaries or wages, payroll taxesPayroll TaxesPayroll taxes are statutory deductions made by the employer from an employee’s regular salary and wages, and usually, such withholdings mostly have both employer and employee equal contributions. These taxes are collected by tax authorities from respective employers and paid for human welfare schemes, infrastructure development.read more, and other benefits paid to a worker.A consumer bears the cost of living, and he or she can be a worker, employer, businessman, unemployed individual, etc. On the other hand, the cost of labor is borne by an employer.

Advantages

Some of the benefits are given below:

  • It helps the management of an organization in managing the labor costs of an organization as it allows the same in the identification of such employees that are under-performing. The management during lay off can get rid of the identified under-performing employees instead of the ones that are performing and delivering as per the expectations.It allows the management to compare the costs of labor to his output or performance.It allows the management to get rid of underperforming employees.Helps the management in avoiding mistakes and creating a labor budget for the company.

Disadvantages

Some of the disadvantages are given below:

  • The calculation totally ignores the time factor in the case of workers that are paid on a piece-rate basis.There is hardly any distinction drawn between the performance of workers that work on machines and ones that work manually.There is hardly any distinction made between skilled and unskilled workers.There is no distinction drawn between fixed costFixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more and variable cost.

Conclusion

The cost of labor is merely an amount that is paid by an employer to his workers. These costs include salaries, wages, payroll taxes, and benefits paid by an employer. It helps the management of an organization in the management of costs, outsourcing, union negotiations, etc.

This has been a guide to what is the cost of labor and its definition. Here we discuss an example and formula to calculate the cost of labor along with advantages and disadvantages. You may learn more about financing from the following articles –

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