Indirect labor costs

From CEOpedia | Management online

Indirect labor costs include various forms of payroll taxes, insurance and a wide range of additional employee benefits[1]They cannot be identified with the individual cost centre and is incurred for those employees who are not engaged in the manufacturing process but only assist[2].

Types of indirect labor costs

Indirect labor expense involves[3]:

  • forms of payroll taxes
  • insurance
  • additional employee benefits

Employer's participation based on the payroll: insurance against unemployment, social insurance, contractor liability insurance and property damage as well as employee compensation insurance.


These costs are significant, often from 35 to 55 percent of the supplements to direct wage costs. The most important in the project is to consider the presence of indirect labor costs - it is less important when and how they arise[4]. Companies can distinguish direct and indirect labor costs so that they can measure the effectiveness or efficiency of their employees, which entails studying how long an employee lasts to produce one unit. If productivity starts to get below the target levels, action can be taken to improve performance[5].


For estimation purposes, the total workload can be calculated in one operation using hourly labor costs are often calculated separately when labor prices are estimated. A common rule is to add a percentage of allowance to the total intermediate direct operation to the other, it may be advantageous to calculate indirect costs run at the same time the direct labor cost is achieved for the service[6].

Direct labor costs

Direct labor costs are wages paid to employees who produce products physically. In other words, these costs are the costs paid to employees who make the products that they produce sell[7]. There is a subtle difference between direct labor and direct labor costs. Work refers to the actual work done by employees to produce products. Labor costs refer to the amount of money that the employer pays employees for doing the job[8].

Examples of Indirect labor costs

  • Payroll taxes: Payroll taxes are taxes imposed on employers or employees, and are usually calculated as a percentage of the wages paid. Examples include Social Security and Medicare taxes, Federal Unemployment Tax (FUTA), and state and local taxes.
  • Insurance: Employers may offer insurance plans to their employees, such as health, life, and disability insurance. These plans can be paid for by either the employer or the employee, and can be partially or fully covered.
  • Retirement benefits: Employers may offer retirement benefits in the form of 401(k) plans or other types of plans, such as pension plans. These plans may be partially or fully funded by the employer.
  • Paid time off: Employers may offer paid time off for holidays, vacations, or other reasons. This can include paid sick leave, vacation time, and personal days.
  • Bonuses/incentives: Employers may offer bonuses or incentives to employees as part of their compensation package. These can include things such as performance bonuses, referral bonuses, and signing bonuses.
  • Training: Employers may offer training programs to their employees in order to improve their skills and knowledge. These programs may be paid for by the employer, or may be an employee benefit.

Advantages of Indirect labor costs

Indirect labor costs provide employers with a number of advantages, including:

  • Increased employee satisfaction and loyalty, since employees feel valued for their contributions and are offered additional benefits such as health insurance and retirement plans.
  • Improved workplace morale and productivity, as employees are more likely to be motivated and productive when they are offered competitive wages and benefits.
  • Lower turnover rates, as employees are less likely to leave a company when they are offered competitive wages and benefits.
  • Cost savings, as indirect labor costs often include payroll taxes, insurance, and other employee benefits, which can be less expensive for employers than directly paying for these services.
  • Improved compliance with labor laws, as employers are less likely to face legal penalties for not providing necessary benefits.

Limitations of Indirect labor costs

Indirect labor costs can be difficult to calculate accurately due to the wide range of associated costs. Some of the limitations of indirect labor costs include:

  • Unpredictable labor costs: Indirect labor costs can vary greatly from month to month, making it difficult to accurately forecast and budget for them.
  • Difficulty tracking: Indirect labor costs can be difficult to track accurately as they are often not itemized on payroll documents.
  • High administrative costs: Significant administrative costs are required to ensure that payroll taxes, insurance, and other employee benefits are calculated and paid correctly.
  • Impact of legislative changes: Changes to payroll taxes, insurance, and other employee benefits can have a significant impact on indirect labor costs.
  • Loss of productivity: Employees who are paid with indirect labor costs may not be as productive as those who are paid with direct labor costs.

Other approaches related to Indirect labor costs

Indirect labor costs include more than just payroll taxes and insurance. Other approaches related to indirect labor costs include:

  • Payroll processing fees - this includes the cost of processing payroll, such as setting up payroll accounts, calculating hours worked, and preparing payroll checks.
  • Employee benefits - this includes additional compensation such as paid vacation, sick leave, and health insurance.
  • Training and development - this includes the cost of providing training and development opportunities for employees, such as seminars and workshops.
  • Recruiting and onboarding - this includes the cost of recruiting and onboarding new employees, such as advertising for new positions and interviewing candidates.
  • Compliance costs - this includes the cost of meeting legal requirements, such as filing taxes and complying with labor laws.

In summary, indirect labor costs include payroll taxes, insurance, and a variety of other employee benefits, payroll processing fees, employee benefits, training and development, recruiting and onboarding, and compliance costs.


  1. Sears S. K.,2008, p.46
  2. Colin A., 2008, p.46
  3. Sears S. K.,2008, p.46
  4. Sears S. K.,2008, p.46
  5. Gildersleeve R.,1999, p107-107
  6. Sears S. K.,2008, p.46
  7. Chiang B.,2013, p.86
  8. Holloway D. M.,2016, p.44

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Author: Agnieszka Katarzyna Sikora