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Direct labor is any type of work that is directly associated with the production of a good or service. Labor of this type does not include tasks accomplished by managers, supervisors, or others who focus more on administrative and organizational tasks. With labor of this type, only those who operate the machines or perform the tasks that result in the production of goods are included.
One of the easiest ways to understand the idea of direct labor is to look at a manufacturing operation. Any employee performing tasks that have to do with the actual assembly or creation of the products produced in the plant would be considered direct labor. Machine operators as well as those who work on the machines are directly involved in the production process, since their efforts allow the machines to produce the goods that are ultimately sold to customers. By contrast, a shift supervisor, while very important to the consistency of the operation, would be considered indirect labor, since his or her contribution to the production process does not include actually producing the products.
A distinguishing characteristic that helps to identify whether a given type of work is direct or indirect labor has to do with how easy it is to assign the direct labor cost. In manufacturing situations, it must be possible to assign the cost of the labor to the products produced. In situations that involve the extension of services, the labor must be associated with specific types of billing codes, such as cost centers, or client matter numbers. In construction settings, the labor must be assignable to some type of work order.
In many countries, governmental regulations determine what can and cannot be considered direct labor. This is especially true in nations where the designation of various types of labor has an impact on how the tax burden for a given company is calculated. In particular, laws that may apply when the work is done as part of a job or work order must be observed closely.
For example, if a quality inspector inspects all products before they leave the factory, regardless of where the products are sold, chances are this important job would be classified as indirect labor, because it could not be tied to a specific work order. Should the inspector be assigned to only asses products produced for a specific work order, applicable laws could possibly allow that effort to be classed as direct labor. Since laws may vary from one country to another, it is always necessary to make sure the classification of labor is always in compliance with current regulations in the jurisdiction where the work takes place.