How do companies set rate and time standards for labor costs? Why are theses standards established?
Direct labor standards are established to control labor costs. Two commonly used direct labor standards are direct labor rate standard and direct labor time standard. The direct labor rate standard is also known as direct labor price standard. These two standards are briefly discussed below:
Direct labor rate standard
Setting direct labor rate standard means calculating an expected hourly rate for labor costs. It includes not only wages per hour but also other costs associated with labor such as fringe benefits, employment taxes etc. The necessary information to calculate standard labor rate per hour is taken from the production department and previous years’ data of the firm.
Suppose, Modex Company’s basic wage rate is $15. Other costs associated with labor are employment taxes which are 5% of basic wage rate and fringe benefits which are 15% of basic wage rate.
The company’s standard labor rate per hour is calculated as follows:
In above example, the standard labor rate is $18.00 per hour. In a highly labor intensive industry, all workers cannot be paid equally. Some workers may be more senior and therefore more experienced than others. The workers with high efficiency are usually paid more remunerations than the workers that are not so efficient. This situation creates a problem in setting labor rate standards. In order to avoid the complications, many companies set an average rate for the department as a whole (as in our example). It makes the implementation of standard costing simple.
Direct labor time standard
Direct labor time standard is the standard time required to manufacture a unit of product under normal working conditions. This time is normally expressed in hours.
In above example, suppose the Modex company calculates standard hours to manufacture a unit of product as follows:
Notice that the standard time required to manufacture one unit of the Modex company is 3.25 hours. It consists of basic time plus allowance for breaks, downtime and rejections.
In our example, the standard time to complete one unit is 3.25 hours and the standard labor cost per hour is $18. The standard labor cost per unit of Modex company is therefore $58.5 as computed below:
= $18 × 3.25hours
Like other cost elements (direct materials and manufacturing overhead), the standard labor cost per unit is written on the standard cost card of the product.