Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.
Companies require plenty of budgets, but one of the most important is the direct labor budget. In this lesson, we see how it is used to do everything from planning vacations to hiring new employees.
Direct Labor Budget
Business accounting is quite different from just balancing your checkbook at home. After all, a typical company usually has much more money to manage than the average American household. However, it also has many more expenses, and those expenses have to be accounted for in very specific ways. This is not only for the purposes of tax reporting but also because good managers want to know where their money is going. As a result, firms must prepare specific budgets for different areas of expenses within their companies.
One of the most common examples of this type of budget is a direct labor budget. A direct labor budget keeps track of all the labor-related expenses as they directly relate to manufacturing. In this lesson, learn how to prepare a direct labor budget as well as how it factors in to other types of accounting documents.
Preparing a Direct Labor Budget
First things first, make sure there is access to all the numbers needed to prepare a direct labor budget. To find those, start by looking at the production budget, which shows how many units have to be manufactured. In addition, find out the hourly cost of labor and the amount of labor needed to manufacture each unit. From here, it is just a matter of multiplying these numbers together to find the total labor cost. First, multiply the total number of units by the cost in time to produce each unit. That gives the total number of hours necessary. Then multiply that by the cost per hour for labor to get the total labor cost.
Of course, companies rarely make one product that just has one set amount of time necessary to build it, nor do they typically pay everyone the same. As a result, direct labor budgets often break down the labor cost for each type of good created by a company, taking into account the different wage costs and different time commitments associated with each.
Other Factors and Uses
As stated, the direct labor budget borrows heavily from the production budget to get its figures. However, it doesn't stop there. The total labor cost as calculated in the direct labor budget is crucial to being able to calculate a company's master budget, as well as its balance sheet and budgeted income statement. Both of these help make sure that a company can meet its bills and continue to produce goods.
However, it's not just as an accounting tool that the direct labor budget offers its worth. It can also be used by human resources managers to help anticipate when a company may need to make new hires, as well as in determining how much vacation time to award each year. In fact, the direct labor budget can even help determine approval of vacation at times when too many people have requested off from work.
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Here's an example of using a direct labor budget and how it works. Say that you own a widget factory. You've just been awarded a contract to produce 100,000 widgets, and you need to know not only how much it is going to cost you in terms of labor but also if you'll need to hire more people. The direct labor budget helps with both.
First, what information do you need to calculate the budget? Well, it takes 500 workers each 15 minutes to construct a widget. Each worker gets paid $15 an hour. The buyer expects the widgets to be done in one week. Now let's take a look at the math.
How much is it going to cost the company? Multiply the number of widgets by the time in hours needed to make one by the pay per hour. That's 100,000 x 0.25 hours x $15. You end up with $375,000 as your cost. However, you still need to know if you're going to have to hire new people to help you achieve that goal.
Stop before multiplying the wage. That gives us 25,000 hours. Now divide that by your total number of hours each employee works during a week. Most firms have their employees work 40 hours a week. 25,000 hours / by a 40 hour work week = 625, which is how many total employees you would need to produce all those widgets on time. Since your company has 500 employees, that means you'd need to hire 125 new employees as temps for that week.
The direct labor budgetis an assessment of all the labor costs directly associated with producing a good. However, beyond its use as an accounting tool, the direct budget is also useful for planning human resources. Remember that the information needed for a direct labor budget starts with the production budget, and this budget is necessary to calculate a company's master budget, its balance sheet, and budgeted income statement. In order to find the direct labor cost, multiply total production by time per unit by cost per labor hour.
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