Definition
Direct Labor Costs can be defined as payroll costs that are incurred to manufacture a certain product. These are the costs that can directly be traceable and attributable to a certain product.
In other words, direct labor can also be referred to as the wages that are paid to employees and the payroll who work directly on manufacturing products and bring them to a sellable condition.
However, it can be seen that this is something that is directly traceable and associated with the production process, and the manufacturing that is carried out within the company. In this regard, this is the outlining difference between direct and indirect labor costs.
Direct Labor Costs are mostly associated with products that exist in a job costing the environment. This is mainly relevant to situations where the workers are expected to record the time spent on various working jobs.
Mostly, these costs are mainly concerned with the production process, and therefore, they are variable in nature. Varying from industry to industry, they are treated on a product basis (in a manufacturing concern), or a client basis (in the service sector).
Difference Between Direct and Indirect Labor Costs
Labor Costs are categorized as direct and indirect labor costs. The main difference between direct and indirect labor costs is the underlying fact that direct labor can be directly attributed to a certain product. On the other hand, it can be seen that indirect labor cannot be directly attributed to any given product.
In the same manner, direct labor is an expense that is incurred on payroll to manufacture the given goods and/or services. On the other hand, indirect labor expense is incurred regardless of the manufacturing status of the company.
Example
An example of Direct Labor would be the wages and salaries paid to workers who are working on the production line to create and assemble a given product.
Accounting Treatment
The Direct Labor Cost is classified as product cost, inventory cost, prime cost, or a conversion cost (in case of manufacturing overhead allocation).
Direct Labor Costs are added to the Work-in-Progress Inventory, at the end of the relevant financial year. The journal entry that is required to record this particular transaction is as follows:
Debit – Direct Labor Expense
Credit – Payroll Payable / Cash
This is because Direct Labor costs are expenses in nature, and therefore, they are supposed to be treated as such. When they increase, they are debited, and the relevant credit entry depends on whether the payment has been made to these employees or not.
Conclusion
To summarize the points made above, it can be seen that Direct Labor Costs are costs that are directly associated with the manufacturing process. These are the costs that are easily be traced or identified to a certain product, and therefore, this can also be referred to as a product cost.
The main rationale behind this distinction is to ensure that product costing can be made possible so that relevant margins can subsequently be created.