Indirect labor costs are the salaries and wages that a business pays to the employees who are not directly involved in the production of goods and performance of services. These support workers perform tasks that are integral to the operation of the business but not directly tied to the manufacturing of the finished product.
Indirect labor encompasses a wide range of roles and positions that include but are not limited to office managers, administrative assistants, human resources, accountants, janitors, security guards, supervisors, and quality assurance workers.
Understanding indirect labor costs and how they are accounted for is essential to maintaining proper accounting records. Fortunately, Skynova offers accounting software that helps you keep track of these costs and stay on top of your business finances.
Keep reading as we provide an in-depth overview of indirect labor costs, how they compare to direct labor costs, and how to account for them in your books.
Indirect Labor vs. Direct Labor
Much like the dichotomy between direct materials and indirect materials, labor is also divided into two categories: direct labor and indirect labor. The former refers to any type of labor that is directly involved in the production of finished goods and services, whereas the latter consists of support labor that is not associated with the manufacturing processes.
In the following sections, we will discuss the two types of labor in more detail, go over some of the key differences between them, and look at how each one is treated from an accounting point of view.
Indirect Labor
In its most straightforward definition, indirect labor is any work that cannot be directly traced to the making of the products or the performance of the services that a company offers. This type of labor plays a supporting role in the company's structure.
Indirect labor employees and workers assist direct labor employees and workers in their work and handle the day-to-day tasks that are essential to running a business. The roles that indirect labor employees perform range from financial duties, such as bookkeeping and budgeting, to tasks like equipment maintenance and appliance repair.
From an accounting perspective, the cost of indirect labor is classified as an indirect cost, which means it is accounted for as an overhead expense for the business, while indirect expenses are incurred during the production cycle and cannot be traced to a specific product or service.
Direct Labor
In contrast to indirect labor, direct labor is any work that involves making a product or performing a service. In other words, direct labor employees engage in tasks that are directly linked to a production process or a revenue-generating service. Examples of direct labor include assembly line workers, laborers, painters, and roofers.
The costs that are associated with direct labor are classified as payroll costs and are directly traceable to a specific product or service.
Is Indirect Labor a Variable Cost?
Depending on the circumstances of each case, the cost of indirect labor can either be variable or fixed. This is mainly due to the fact that employees are compensated in different ways. For example, a human resources manager is paid the same amount of money regardless of business activity. Therefore, this expense is a fixed cost for the company.
On the other hand, certain compensation packages can vary depending on the company's production and schedule. For instance, an accountant who gets paid on an hourly basis might need to work overtime during periods of increased activity. In this case, the employee's compensation is directly linked to the volume of business activity, which makes it a variable cost for the employer.
What Is an Example of Indirect Labor?
Indirect labor employees make up a significant percentage of a company's workforce, and their job responsibilities range from menial maintenance tasks to complex legal duties. Here are examples of some of the most common indirect labor positions:
- Office managers: Their main responsibility is to make sure day-to-day office operations are running smoothly. As part of their tasks, office managers oversee administrative assistants and other support staff. Office managers are expected to be quite versatile and adept at interpersonal communication.
- Legal advisers: Large organizations often employ legal advisers that can help them navigate regulatory ambiguities and tackle potential legal issues before they even surface. A legal adviser can also review the company's internal policies and recommend appropriate changes. They are typically compensated on an hourly basis.
- Accounting staff: Accountants have a myriad of responsibilities within an organization. Besides keeping records of all financial transactions, accountants are also tasked with generating and interpreting financial reports, preparing tax returns, and ensuring compliance with financial regulations.
- Maintenance staff: Maintenance workers are integral to any manufacturing setting. Their job duties can include everything from repairing and maintaining equipment to fixing air conditioning systems and doing flooring repairs.
- Security guards: Their job is to make sure that the production area is safe at all times. The presence of security guards provides a sense of safety to employees and employers alike.
- Quality control staff: Quality control inspectors occupy a critical role in a manufacturing setting. They are responsible for monitoring the production process and ensuring that operations are up to the required standard.
- Marketing professionals: Effective marketing strategies are what allow businesses to build awareness for their products and boost sales. Marketing professionals are tasked with identifying these strategies and implementing them to drive more business.
What Is the Journal Entry for Indirect Labor?
While the accounting treatment of indirect labor is fairly similar to that of direct labor, the two differ when it comes to classification. Since indirect labor costs cannot be traced back to an individual product or service, they are classified as overhead costs on the income statement. On the other hand, direct labor costs are treated as prime costs. Here is a simplified example that illustrates how an indirect labor cost is accounted for:
Let's assume that company A employs a single marketing strategist, who earns a monthly salary of $4,000. The journal entry to record the payment of this expense is as follows:
| Debit | Credit | |
|---|---|---|
| Indirect labor expenses | 4,000 | |
| Cash/payroll payable | 4,000 |
Journal entries, such as the one above, can be prepared in less than a minute using Skynova's all-in-one invoice and accounting software. This all-encompassing solution comes with a journal transactions feature that enables users to make year-end adjusting entries, record cash investments, and accrue interest on loans. Moreover, the interface boasts an intuitive design and the entire system is very user-friendly.
Let Skynova Help You Manage Your Small Business Accounting
Maintaining an accurate record of indirect labor costs offers a lot of benefits to your business. As a matter of fact, proper accounting of all your costs allows you to generate accurate financial reporting, assess profitability, determine the ideal pricing for your products or services, set more realistic budgeting goals, and have better control of your expenses.
Skynova's accounting software helps you achieve this by providing a cutting-edge expense tracking system. Using this software, you will be able to upload and store your receipts in an organized manner, maintain an organized ledger where expenses can be retrieved with ease, and bill expenses directly to your customers.
There are very few software solution providers that understand the needs of small business owners as well as Skynova. Check out our other software products and business templates and see how they can help improve your business.
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Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional accountant to ensure you're meeting accounting standards.