Here’s a challenge that could face some manufacturing companies in their financial reporting.

The direct labor dollars that are actually spent may not be shown in the financial reporting package. What gets shown might be standard direct labor information or the direct labor cost of sale. But, nowhere in the financial statement does it show what was actually spent during the month in direct labor.

What causes this? Having direct labor setup going right to inventory. Now, this may not sound quite so bad in of itself, but what you’d lose is some tracking in the process.

If possible, you want to be able to show what direct labor dollars were actually spent. Even better is to be able to break this down by key manufacturing departments. See if you can setup the general ledger to have your direct labor go there rather than right into the inventory account. Then have it work like overhead where direct labor is absorbed into the inventory cost.

Ideally, for the reporting and direct labor, you want to be able to see the following components:

1. What exactly was spent on direct labor during the month? This should include things such as regular time, overtime and any particular downtime.

2. How much labor was actually utilized in production?

3. What your absorption rate was? In other words, how did your labor absorbed into inventory compare against how much you actually spent on direct labor? This will help you get a measure on your production activity, as well as insights into how good your standards might be.

Consider the alternative, just having labor going right into inventory and no direct labor reporting on the financial statements. You’re missing all this very valuable information.

So, if you don’t have that kind of reporting on your direct labor, I strongly urge you to change your accounting practices to put this information in place. This will not change at all, your bottom line numbers, but what it will do is give you more detailed breakouts that are so important to gain a better handle on your direct labor cost. Once you have more of a handle on these costs, you can take stronger action, better control your spending and become more efficient in your manufacturing process.

Jon Paul, MBA, CPA, CMC, CM&AA

President, Value Added Finance Resources
Bringing new insights on results and maximizing company value