The difference between direct and indirect labor
/What is Direct Labor?
Direct labor includes all labor that varies with production volume. This means the classification is generally limited to those people working on an assembly line or operating production machinery.
What is Indirect Labor?
Indirect labor is all types of support and supervisory labor, such as janitorial, maintenance, administrative, and management employees. Indirect labor is much less likely to change with production volume, since it represents the overhead of a business that is needed to support any level of operations.
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Comparing Direct and Indirect Labor
The difference between direct labor and indirect labor is that only labor involved in the hands-on production of goods and services is considered to be direct labor. All other labor is, by default, classified as indirect labor. This distinction is important from an accounting perspective, since the two types of labor are treated differently. The accounting is noted below.
Accounting for Direct Labor
The cost of direct labor is charged to all units produced during the reporting period. The basis for charging the cost is the number of hours of labor actually used in the production process. These costs are then charged to the cost of goods sold, if the underlying finished goods are sold to customers within the reporting period. If not, then the costs are recorded as part of the ending inventory asset, which appears on the balance sheet.
Accounting for Indirect Labor (Factory)
The cost of indirect factory labor is assigned to a cost pool, from which it is allocated to the units produced during the reporting period. Depending on the level of allocation sophistication, several cost pools may be used, each of which has a separate allocation methodology. For example, a cost pool for real estate costs could accumulate factory rent, and then be allocated out based on the amount of square footage used. Meanwhile, another cost pool for maintenance costs could accumulate maintenance labor and equipment costs, and be allocated based on machine hours used.
Accounting for Indirect Labor (Administrative)
The cost of indirect administrative labor is charged to expense in the period incurred. It never appears in the balance sheet as an asset. Instead, it is charged to the applicable administrative department on the reporting entity’s income statement, typically below the cost of goods sold line item.