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Direct labour budget

Category: Budgeting Methodology

The direct labour costs, as a principle, are to be developed on the basis of the individual products planned to be produced. They can be developed on the basis of the products planned to be sold if no change of work-in-progress or finished goods inventory is budgeted for the planning period.

Because the different products cause different labour cost in the workshops which contribute to the manufacturing process, the planning has to be done by workshop. The technical documentation as to the work to be carried out – how many minutes of direct work have to be spent in the different work shops, and at what rate – serves as basis for calculating the direct labour cost budget in using the formula:

calculating the direct labour cost budget

Attention has to paid to the fact that in the case of work which is not paid “by piece”, the time per unit (the norm) might be over-, or understated, i.e. not be established in accordance with the principle of “attainable performance under efficient operating conditions”. Using such norms for budgeting will automatically lead to a wrong direct material cost budget.

In the case of the sample company Eurotransform, the direct labour budget calculation is carried out for 14 workshops by month in accordance with the planned delivery date of the final product, and in splitting the labour cost into “incentive paid work” (paid per piece), and “straight paid work” (paid by hour). This calculation shows which direct labour cost are caused in the different workshops by the final products due for delivery in January, February, March, etc. The calculation, however, does not indicate at what point in time of the production cycle the labour cost becomes cash outflow effective. (for example, in the case of delivery by the end of June, production has to be launched for category II – III products in April, for category IV — VI products in March). A direct labour payment pattern, therefore, has to be assumed similar to the one used for direct materials (%age distribution of cash outflows during the production cycle time for transformer sizes II-III, and IV-VI).

The problem of budgeting overheads (or indirect cost) stems from the fact that overhead cost are not connected directly to individual products, orders or services, as are the direct cost.

Some indirect costs, however, are still relatively close to direct costs. The labour cost caused by a workshop supervisor, certainly, cannot be related to individual work operations, as can the labour cost of direct workers. Each workshop, carrying out productive work has to bear such indirect cost of its own. But the supervisor’s cost, and other indirect cost incurred, can be related to the productive work done by the workshop, and via the productive work, to the products.

Other indirect cost are spent in departments which only carry out indirect activities, e.g. building maintenance and repair. These functions are referred to as auxiliary functions. The costs of auxiliary functions, too, have to be put in relation to the productive functions in order to relate them to products. This putting in relation is referred to as “distribution” and “allocation”

  • the cost of auxiliary activities, recorded in accounting by type of cost and by organizational function, are distributed to the direct activities who have to carry them in an accordance with the contribution they make to their work.
  • the total indirect cost identified as belonging to one productive activity (i.e. the indirect cost of the productive activity plus the distributed cost of the auxiliary activities) are then allocated to products, or processes.

This is explained in more detail in the following.

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