Initially on the surface, one may interpret labor rate as simply how much it costs to pay an employee for their time on the job or project. However, as you dig deeper into how labor rate is derived, you will find there to be much more detail involved than just the cost of their base salary. When considering labor rates, the employee’s wages are absolutely included. However, other costs of employing that person have to be considered such as overtime, taxes, pensions, insurance, etc. (Bragg, 2020).
When billing a customer for labor, an employer has to consider adding a few elements to the rate to ensure they have necessary expenses paid for and can also make a profit. Otherwise, their business will not be sustainable. Companies are not in the business of losing money. In order to ensure the proper labor rate is being charged, it is important to ensure a portion of overhead expenses are included in the labor rate along with a profit percentage (Bragg, 2020).
Recovering overhead is something that contractors can take in to consideration when calculating their labor rates. One method of doing this is by estimating the labor hours and amount of overhead and then divide overhead by the hours of labor expected (Pfledderer, 2014). This will ensure overhead expenses are covered so that they do not eat into the profits as much. The company can essentially push overhead costs to the customer via inflated labor rates. However, it is important to keep overhead costs down so that labor rates do not get too high. The market price of labor might not be able to meet higher costs if overhead is too steep.
Bragg, S. (2020, February 06). How to calculate a labor rate. Retrieved from Accounting Tools: Accounting CPE Courses & Books: https://www.accountingtools.com/articles/how-to-ca…
Pfledderer, S. (2014). The ‘simple and stupid’ overhead recovery method: three contractors and a consultant stand by recovering overhead in labor rates. Landscape Management, 53(8), 40. Retrieved from https://web-a-ebscohost-com.ezproxy1.apus.edu/ehos…
STUDENT 2 (Johanna):
One must consider the standards cost of overhead if you own or manage a business. Knowing the total cost of overhead helps a company to assess how much they should charge for product or services to make a profit. Each year, business will project the estimated amount of activity and overhead. This is commonly referenced as a pre-determined overhead rate. The three components to factor the predetermined overhead job costs is direct materials, direct labor and applied overhead.
For example, my hairdresser owns an independent business in Destin FL. She provides services in cutting, washing, waxing, coloring hair. As you can imagine this is a very labor-intensive job. Let’s assume that my hairdresser has determined at the beginning of the year she intends on utilizing 2,000 direct labor hours. Her estimated overhead which factors: booth space rent, education, licensing and insurance, hair cutting tools, backbar supplies, hair styling tools is $21,000 a year.
The predetermined overhead is calculated by the Predetermined overhead rate=estimated overhead/estimated activity, (Adkins, W.,2019).
The predetermined overhead rate would be $10.50. It costs the hair stylist $10.50 to cut hair for one hour. To break it down further, let’s assume that woman’s basic hair cut is $40 and a man’s basic hair cut is $20. In a matter of two hours’ time, a stylist can bring in approximately $40 to $80 per hour. The $10.50 operating cost leaves the stylist with $29.50 an hour for profit. Keep in mind that price varies on the complexity of the hair thickness and length.
As you can see, it is important to understand the overhead rate and estimated activity to accurately assess the profit of a business. Underestimating could eat into a companies bottom-line.
Adkins, W. (2019). How to Calculate the Overhead Rate Based on Direct Labor Cost. Retrieved 23 July 2020, from https://smallbusiness.chron.com/calculate-overhead-rate-based-direct-labor-cost-10313.html#:~:text=You%20may%20also%20calculate%20the,hour%20(%242%2C000%2F100).
This week’s forum tasked us with explaining how to derive the labor rate and how that relates to the total company overhead. To begin, let’s define labor rate. According to Accounting Tools, “labor rates are used to determine both the price of employee time charged to customers, and the cost of that employee time to the employer” (Accounting Tools, 2020). Labor rate can further be refined into Incremental labor rate or fully loaded labor rate. Incremental labor rate “is the cost of labor that will be incurred if a specific action is taken” (Accounting Tools, 2020). Fully loaded labor rate “contains every possible cost associated with an employee, divided by the total number of hours worked by the employee” (Accounting Tools, 2020). To gain a better understanding of both, here is an example of each:
Incremental labor rate- The best example of this would be in asking an employee to work an additional hour. The additional hour would include the employees base wage, plus overtime, minus taxes. For each employee this will showcase a different number and rate, since everyone is not getting the same base wage.
Fully loaded labor rate- With fully loaded labor rate, the roll-up of the rate could contain information for the employee’s base wage, pension, all benefit costs, overtime costs, etc.
The way that labor rates relate to the total company overhead is through direct labor costs associated with the given product or service. You are able to identify the direct labor involved in completing a task or item of that nature and can apply the labor rate to develop a cost overhead directly associated with labor.
Accounting Tools. (2020, February 6). Accounting Tools: Accounting CPE Courses and Books. Retrieved from How to calculate a labor rate: https://www.accountingtools.com/articles/how-to-ca…