Labor Costing: Definition; Characteristics; Steps Of Labor Costing; Pay Schemes; Advantages And Disadvantages

Main objective: The learner will be able to describe the whole process of labor costing in an organization

Specific objectives: The learner will be able to;

  1. Define the term labor costing
  2. Describe the Characteristics of labor costing
  3. Master the six steps of labor costing in an organization
  4. Explain the advantages and disadvantages of using labor costing in remuneration determination

Definition The Term Labor Costing

Labor costing is the step-by-step guideline on how the total labor cost is determined.

Characteristics Of Labor Costing

  1. Labor costing applied or cuts across all categories of industries.

There is no single firm that does not have laborers even if they are few and so the issue of assessing the amount of remuneration to be paid is a common practice all over.

  1. Labor costing is a guideline to the extent to which a customer specification is adhered to.

Labor costing is based on the nature of the client or customer nature of task being undertaken. Such that if the task involves technical touch, labor costing will also factor in the technicalities there of. If the job being done is simple, similarly, simple labor costing follows suit.

  1. Labor costing entails labor analysis for each category of work to be done

That is, all manner of jobs tied to laborers has to undergo labor scrutiny so as to highlight the requirements for each job so as to do appropriate labor costing.

  1. Labor costing is dominated by demarcation of labor account

Labor costing is characterized by keeping or maintenance of diverse labor accounts for each task differ with one another and so different accounts are necessary to avoid confusion and conflict of interest.

  1. Separate treatment of each laborer’s task

Each task associated with a particular laborer is treated differently because even the point number 4 aforementioned tells it all. That each job is unique and should be treated so.

  1. Profit & loss made on each job is found separately

Labor costing entails expenses charged to profit and loss account and so in this financial statement is should be carefully considered to avoid mix-ups.

Steps In Labor Costing

There are SIX (6) steps to be followed closely when doing an effective labor costing. They are as explained below



In this step, data concerning worked hours history for each employee is collected for reconciliation purposes. The information is sourced from the clock card which entail the number of hours each employee works during a pay period. This becomes the source document for the payroll department for payment preparations. This not only creates a document that the payroll clerk can use for preparing payroll, it also creates an internal control.


In this stage, the rightful officer confirms and approves the actual hours worked by each employee which is achieved by ensuring the right authorization for quantity of hours as far as job times is concerned is set.


At this stage, the right pay is determined using the appropriate labor cost determination formula. The labor cost amount are in two forms or levels, namely gross and net.

Pay schemes are several. To compute the labor cost, the employee record card is used to identify the accurate wage rate to be used, allowances to be added to the basic pay, tax liabilities to be charged and any other deductions. This information is the one used to adjust the gross labor cost/wages to net pay.


After step three above, the next move is to prepare the payroll document which entails a list of employees for a specific firm or organization who are entitled to receive payments and other related benefits which are detailed based on how much each has to receive at some point in time as a reward for the time worked or tasks performed. 


This is the step of actual rewarding of the employees as per the payroll records. The amount paid to each employee is net of all deductions at source.


In step six, the accounting treatment of wages paid and the amounts to be paid to other parties such as PAYE, National security fund and other accounts such as employee’s loan facility account is recorded. This is usually a Credit (CR) entry. On the other hand, wages amount associated to payroll as supported by the job cards/or timesheet are posted on the Debit side of the gross wages account then to work in progress account for direct wages and related overheads.

Pay Schemes

The management need to adopt either of the EIGHT (8) of the methods used to determine labor cost in most of the organizations.

Advantages Of Labor Costing

  1. Eradicates any confusion amongst employees for the details of each category of payment is well articulated
  2. Helps in determination of the firm’s profitability. Labor costing is a process whose end results is coming up with expenses related to labor which is chargeable in the profit and loss account which is a tool for profit or loss establishment
  3. Helps in avoiding the problem of job duplication. Labor costing eliminates scenarios of double counting which may result to resource mismanagement.
  4. Labor costing increases productivity efficiency. Since the process of labor costing factors in all aspects of good work, the employee is aware that the wages associated with that job appreciates his or her efforts. So he will be dedicated to improve productivity.
  5. Labor costing helps in correcting any deviation from the expected output. Since labor costing puts in place all the requirements of a job, any deviation from the normal is easily rectified.
  6. Helps in budgeting process. Labor costing is a key step of identifying the resources needed for production to take place which is part of production budgeting.
  7. Helps in determination of overhead costs. Overheads costs are easily calculated because most of the times, labor cost is the basis of computing overhead related cost of the firm. 

Disadvantages Of Labor Costing

  1. Labor costing is a costly exercise. This process has an economic implication to the organization such that the firm faces cash outflow which adversely affect the profitability levels.
  2. No universally accepted procedure/labor costing process. Each firm has a way of determining labor cost and as a result, hence comparison of financial results amongst firms in the same industry is hard.
  3. Require a lot of clerical work. This is cumbersome process for the management may require a lot of paper work which is tedious.
  4. Labor costing may turn to be an irrelevant process. When you consider what is happening in the labor market, the whole process may be turn unnecessary for the forces of demand and supply may dictate a different direction for the firm to take.

About the Author - Dr Geoffrey Mbuva(PhD-Finance) is a lecturer of Finance and Accountancy at Kenyatta University, Kenya. He is an enthusiast of teaching and making accounting & research tutorials for his readers.