Indirect Labor Costs can be defined as costs that cannot be directly traced to an individual product. These are the costs that are incurred across the course of time, regardless of the output that the company is operating.
These are overheads that the company incurs, and therefore, they can be referred to as fixed costs. Given the fact that they are not attributable to any given product, they are therefore spread across products using an allocation basis, in case of a manufacturing concern.
In the cases where the main operations of the company relate to trading, it can be seen that these overheads are simply placed as other costs that are associated with the production process.
Difference between Direct and Indirect Labor Costs
Direct Labor Costs are costs that are incurred during the manufacturing process, and therefore, these costs can also be directly traceable and attributable to a given product.
They are non-variable in nature. On the other hand, as far as Indirect Labor Costs are concerned, they are mainly fixed, regardless of output level the company is operating at.
Therefore, these have to be spread evenly across products in the case where the company is a manufacturing concern and produces a single product.
An example of Indirect Labor Cost can be the salaries and wages for the labour force that is hired as administrators. Similarly, auditors, accountants, and human resource professionals all belong to the ancillary functions of the company.
Therefore, they cannot be associated with a particular product, as a result of which they are treated as indirect labour costs.
The accounting treatment of indirect labour costs is similar to the accounting treatment of direct labour, excluding one main difference.
The main difference is in the positioning and classification of this particular costing. In the case of direct labour costs, they are associated with Prime Costs and specific product costs.
On the other hand, indirect labor is mainly treated as an overhead expense, and in the case where they cannot be related or attributed to a single product, they are mainly treated as overheads in the income statement.
As far as relevant journal entries are concerned, indirect labour is an expense. By the nature of the account, it is debited, when the expense is incurred. On the contrary, credit entry involves making adjustments for payments (or accruals) that are made as a result of this expense. This is further illustrated below:
Debit – Indirect Labor Expenses
Credit – Payroll Payment Payable / Cash
Therefore, to summarize the points made earlier, it can be seen that indirect cost is mainly the cost that is associated with the running of the organization in a smooth manner.
As a matter of fact, it can be seen that regardless of the fact that it is a payroll cost, and ‘indirectly’ relates to the manufacturing process, yet it cannot be attributed to a single unit of product, as a result of which it is treated as an overhead.