Direct Labor Budget

Learning Outcomes

  • Prepare a direct labor budget

A flowchart titled “Types of Budgets”. The labor budget is highlighted in yellow. At the top is the sales budget. The sales budget has two arrows pointing to the production budget and the SG&A budget. The production budget has three arrows pointing to the materials budget, labor budget, and manufacturing overhead budget. Those three budgets are all pointing to the cost of goods sold budget. The sales, production, materials, labor, manufacturing overhead, cost of goods sold, and SG&A budget boxes are all blue and there is a bracket labeling those as the operating budget. Below the operating budget is a horizontal line showing the capital expenditures budget in red on the left, and going to the right from there, an arrow pointing to the cash budget, with another arrow pointing to the budgeted income statement, and a final arrow pointing to the budgeted balance sheet. The cash budget, budgeted income statement, and budgeted balance sheet are all green and there is a bracket labeling those as the operating budget. There are also arrows pointing from the cost of goods sold budget and the SG&A budget to the cash budget.

The direct labor budget is relatively simple. We need to know the units required from the production budget. Next, we need to know how many direct labor hours it takes to complete one unit and the cost per labor hour. Using this information, we can determine how many direct labor hours are required to meet the budgeted level of production. We will take the production units x direct labor per unit to get the number of direct labor hours. Finally, we will take the direct labor hours x the rate per hour.

GelSoft has set a standard of 0.25 hours of direct labor for each gel seat produced at a standard hourly rate of $40 per hour that includes benefits and taxes. The direct labor budget for the year would be:

Units to be manufactured * hours per unit * labor cost per hour

158,605 units * 0.25 hours per unit * $40 per hour = $1,586,040 total direct labor cost

GelSoft
Direct Labor Budget
Description Amount
Budgeted units to be produced 158,605
Direct Labor per unit in hours 0.250
Total direct labor hours needed Single Line39,651
Projected labor cost per hour $40
Budgeted cost of direct labor Single Line$1,586,040Double line

 

This seems fairly straight-forward, but budgeting quarterly reveals a problem:

GelSoft
Direct Labor Budget
Description Q1 Q2 Q3 Q4 Year
Budgeted units to be produced 24,000 42,700 44,800 47,105 158,605
Direct Labor per unit in hours 0.250 0.250 0.250 0.250
Total direct labor hours needed Single Line6,000 Single Line10,675 Single Line11,200 Single Line11,776 Single Line39,651
Projected labor cost per hour $40 $40 $40 $40
Budgeted cost of direct labor Single Line$240,000Double line Single Line$427,000Double line Single Line$448,000Double line Single Line$471,040Double line Single Line$1,586,040Double line

 

If we assume the company is operating 13 weeks per quarter (52 weeks per year) then the number of employees, measured by full-time equivalents (FTE), needed to work in Q1 is 12. Twelve full-time employees working 40-hour shifts for 13 weeks = 6,240 hours.

However, for Q2, Q3, and Q4, we need 21 to 23 FTE. Assuming at present the company has 20 full-time workers (20 workers * 40 hours per week * 13 weeks = 10,400 hours) then, according to the above schedule, the company would have to lay off eight FTE during Q1 in order to reduce production and therefore deplete beginning inventory by the end of Q1. That may not be practical.

Thus, the budget team will probably revise the quarterly production schedule to phase out beginning inventory over the year, rather than in one quarter:

GelSoft
Production Budget in Units – Revised to phase-out beginning inventory gradually
Description Q1 Q2 Q3 Q4 Year
Budgeted/Project sales, in units 40,000 42,000 44,100 46,305 172,405
Plus: ending inventory target 27,000 24,000 21,000 16,200 16,200
Total units needed to meet goals Single Line67,000 Single Line66,000 Single Line65,100 Single Line62,505 Single Line188,605
Less: units in beginning inventory 30,000 27,000 24,000 21,000 30,000
Units needed to be produced to meet goals Single Line37,000Double line Single Line39,000Double line Single Line41,100Double line Single Line41,505Double line Single Line158,605Double line

 

Which will also change the quarterly production budget:

GelSoft
Direct Materials Budget – revised
Description Q1 Q2 Q3 Q4 Year
Budgeted units to be produced 37,000 39,000 41,100 41,505 158,605
Direct materials needed per unit (Kg) 0.680 0.680 0.680 0.680
Total Kg direct materials needed Single Line25,160 Single Line26,520 Single Line27,948 Single Line28,223 Single Line107,851
Plus: desired DM in ending inventory (Kg) 8,800 9,300 9,400 11,200 11,200
Less: DM in beginning inventory (Kg) (25,000) (8,800) (9,300) (9,400) (25,000)
Budgeted purchase of direct materials Single Line8,960 Single Line27,020 Single Line28,048 Single Line30,023 Single Line94,051
Projected cost per Kg $11 $11 $11 $11
Budgeted cost of direct materials to be purchased Single Line$98,560Double line Single Line$297,220Double line Single Line$308,528Double line Single Line$330,253Double line Single Line$1,034,561Double line

And the direct labor budget:

GelSoft
Direct Labor Budget – revised
Description Q1 Q2 Q3 Q4 Year
Budgeted units to be produced 37,000 39,000 41,100 41,505 158,605
Direct Labor per unit in hours 0.250 0.250 0.250 0.250
Total direct labor hours needed Single Line9,250 Single Line9,750 Single Line10,275 Single Line10,376 Single Line39,651
Projected labor cost per hour $40 $40 $40 $40
Budgeted cost of direct labor Single Line$370,000Double line Single Line$390,000Double line Single Line$411,000Double line Single Line$415,040Double line Single Line$1,586,040Double line

 

The revision balances out the reduction of inventory and the direct labor needs. This is why quarterly or monthly budgets are important in addition to the annual budget.

Notice that the totals do not change, only the quarterly materials and labor requirements.

Based on this revised production budget, FTE needs by quarter are as follows (based on direct hours needed divided by 13 weeks divided by 40 hours per week):

Q1 – 18 FTE

Q2 – 19 FTE

Q3 – 20 FTE

Q4 – 20 FTE

We’ll use this revised production budget for the rest of this example as it continues to unfold in this section on the operating budget.

Here is a short video on how to compile a direct labor budget.

You can view the transcript for “Direct Labor Budget” here (opens in new window).

Now, check your understanding of the direct labor budget.

Practice Question