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The workforce is essential in many industries. Whether service- or product-based, businesses need employees in many areas. In manufacturing companies, these employees also help contribute during the production cycle. The work done by them falls under the definition of labor. It includes any effort, skill, and time employees put toward producing goods and services.
Companies must classify labor expenses into various categories based on different classifications. One of these includes differentiating between direct and indirect labor. Before discussing the differences, it is crucial to understand them individually.
What is Direct Labor?
Direct labor includes the cost of employees directly involved in the production process. These employees are typically the ones who physically create or deliver the product. For example, they may consist of assembly line workers, machine operators, or delivery drivers. Any costs associated with these employees also become a part of the product good’s cost.
Direct labor costs include the wages, salaries, and benefits paid to these employees. They can also include other labor-related expenses directly tied to the production process. For example, they may consist of training costs or equipment maintenance costs. Usually, direct labor is a variable cost and fluctuates with changes in activity levels over a specific time.
What is Indirect Labor?
Indirect labor refers to the labor costs associated with running a business. It does not include employees not directly involved in creating or delivering a product or service. Usually, these employees and expenses back the production process. For example, it may include employees in finance, administration, and other departments. Although they support the production process, they are not directly a part of it.
In the production process, indirect labor falls under overhead. Essentially, it means these costs do not become a part of the cost of the underlying product. Nonetheless, indirect labor is still an expense incurred by a company. These costs are a part of the overall profitability of the company. Despite the name, indirect labor is still essential in running a business and its operations.
What is the difference between Direct and Indirect Labor?
Direct and indirect labor differs in the following areas.
Definition
Direct labor refers to the labor costs linked to employees directly involved in producing a good or service. Indirect labor refers to labor costs associated with employees supporting the production process.
Behavior
Direct labor costs are typically variable costs because they increase or decrease with the production levels. In contrast, indirect labor costs are fixed costs because they do not fluctuate with activity levels.
Allocation
Direct labor becomes a part of the product’s cost. However, indirect labor falls under overheads. While both are crucial for the company, both play different roles in calculating profits.
Identification
Companies can identify and trace direct costs to a specific product or service. However, tracking indirect costs and associating them with one item requires complex processes.
Importance
Direct labor is a critical component of product costing and helps determine the cost of goods sold. In contrast, indirect costs are not as crucial. However, these costs still help measure the overall profitability of a company.
Conclusion
Labor refers to the costs associated with employees and the work they do. Companies may divide these costs into several categories, including direct and indirect. However, both play a role in overall profitability. Direct labor usually includes employee costs associated with employees contributing to the production process directly. Any expenses that don’t fall in that category get classified as indirect.
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