The cost components of work-in-process and inventory goods will inevitably include some labor. However, the proportion of labor in the total cost mix has dropped markedly over the years, with material and overhead costs now predominating.
Nonetheless, the costing reports the accounting staff has traditionally generated are mostly concerned with labor. Examples of these reports are those detailing overtime, comparing actual to standard labor rates or usage, and labor efficiency. By comparison, the reports concerned with the materials expense typically cover only scrap rates and purchase price variances, while many companies have no reporting for overhead costs at all. Hence, most accounting departments are misallocating their time in reporting on the smallest component of product costs.
How To Address This Issue?
The best way that addresses this problem is one of the easiest to implement—simply stop reporting on labor variances. The accounting staff will have more time to spend on reports concerning costs that make up a larger proportion of product costs. The problem with this best practice is the remarkable uproar it frequently incites, especially on the part of traditional production managers who were raised on the concept of tight control over labor costs.
Thus, the best way to implement this item is to carefully educate the production staff on the following points:
Direct Labor Is Really a Fixed Cost
In many manufacturing situations, the direct labor staff cannot be sent home the moment there is no work left to do. Instead, a company must think about retaining them since they are trained and more efficient than other people who might be brought in off the street. Accordingly, it makes a great deal of sense to guarantee regular working hours to the direct labor staff (within reason). By doing so, it becomes apparent that direct labor is not a variable cost at all and requires much less detailed investigation and reporting work for the accounting staff.
Other Reports Are More Valuable
If the accounting department only has enough resources to issue a fixed number of reports, there is a good argument for eliminating the least useful ones (labor reporting) in favor of ones involving more costs, such as materials and overhead. One can reinforce this argument by formulating trial report layouts for new reports that will replace the labor reports.
Target Costing is The Real Area Of Concern
Many studies have shown that costs are not that variable once a product design is released to the factory floor. Instead, the primary area in which costs can truly be impacted is during the product design. A strong argument in this area, especially if combined with visits to other companies that have installed target costing, will go a long way toward convincing management on this point. If production management can be convinced that these three points are accurate, it becomes much easier to eliminate labor variance reporting, either completely or in part.
The only situation in which this best practice should not be implemented is one where labor costs still make up the majority of product costs (an increasingly rare situation) and where those costs are variable. If labor costs are highly fixed in nature, there is not much point in continuing to issue reports showing that the costs have not changed from period to period.