## Direct Labor Budget

### Learning Outcomes

• Prepare a direct labor 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

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

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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:

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Which will also change the quarterly production budget:

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And the direct labor budget:

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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.