Labor cost is one of the main components of cost classification by nature. The term labor does not only cover the employees working physically in production, but also covers the employees working for the business in any department whether providing a physical or mental contribution. Thus, labor cost includes all the salary and wages paid to those employees plus the benefits, taxes and etc. Therefore, expenditure on labor occupies a major place among total costs.

Labor costs emerge because of two fundamental activities, which are manufacturing and nonmanufacturing. Labor costs have several components that are different from each other. At the core of labor costs, there is payment. That payment may be in the form of a wage or salary. Salaries are fixed payments to employees for their performance and productivity working on a monthly basis. However, wages are payments to employees working on an hourly or daily basis. Wage is, in general terms, the amount of money to be paid in cash by an employer or by a third party to a person in return for work performed by him.

• Basic Pay
• Week and Holiday Pays
• Overtime Payment/Premium
• Night/Shift Payment/Premium
• Production and Efficiency Premium
• Holiday Pay
• Allowances (ie. traveling allowance)
• Education and Training Payments
• Social Welfare Contributions
• Health Payments
• Severance Payments
• Social Security Premiums
• Unemployment Insurance Premiums

Labor costs can be divided into two groups as labor costs related to actual work and labor costs related to legal or/and contractual enforcement or discretionary reasons. Basic pay, overtime pay and production and efficiency payment are directly related to the actual work of the employee. Basic pay is received in return for regular work. Overtime pay and premium are received for overtime work that is work exceeds forty-five hours in a week. Overtime pay is considered as labor cost related to actual work, where overtime premium is considered as labor cost related legal or/and contractual enforcement or discretionary reasons. Because paying a premium for overtime work depends on the employer’s desire. Moreover, production and efficiency payment is directly related to efficient work. Labor costs related to legal or/and contractual enforcement or discretionary reasons include week and holiday pays, overtime premium, night/shift premium, social welfare contributions, health payments, holiday pay, allowances, education and training payments, severance payments, social security premiums and unemployment insurance premiums.

Costs are classified as direct and indirect according to traceability to cost objects. Costs that are traceable to a specific cost object are referred to as direct costs; costs that are not traceable to a specific cost object are referred to as indirect costs. Regarding this distinction, labor costs are classified as direct and indirect. However, before defining direct and indirect labor costs it would be better to make the distinction between direct labor and indirect labor. Direct labor, in other words, direct workers are
the employees who are physically involved in the production process. Indirect labor, in other words, indirect workers refer to employees who are not directly involved in the production process. For instance, the employees that work in the assembly line to convert raw material into a product are direct labor. However, the supervisor of those employees is indirect labor. In addition, the maintenance staff, cafeteria staff are also classified under indirect labor. By this means, it is clear that direct labor covers the
employees working in production and convert in raw materials into products and indirect labor covers employees not only working in production but also other departments serving to production. Considering direct labor and indirect, labor distinction direct labor costs and indirect labor costs are explained in detail below.

Direct labor costs refer to wages or salaries paid to direct employees for the work performed. Direct labor costs are directly assigned to the cost of goods produced or services rendered. There are two main points for determining the labor cost as direct;
• payment must be done to employees to make a product or render a service, and
• those employees must be clearly involved that production or service process that are defined as direct labor.

There are three main methods to determine basic pay. Those methods are the time-based system, piecebased system (accord system) and premium-based system. These are also called remuneration systems.

Under the time-based system, the important point is the time that employee spends at work. The measure of time can be the hour, day, week or month. Under this system, productivity is ignored, only time is considered. Therefore, there may be some employees betraying firms’ trust and focusing only time spending at work instead of working efficient. The ignorance of productivity is the disadvantage of this system. Maybe Employee #2 produced 1,000 units in 140 hours and Employee#1 produced just 800 units in 160 hours.

Under the piece-based system, the output is considered. This system focuses on the units that employees produce and ignores the time spent. This kind of system is only applicable to businesses where efficiency is measurable for employees. Basic pay increases in proportionate with produced units.

The piece based system makes employees work harder in order to earn much more money. However, like other systems, this system also has disadvantages. For instance, in order to produce more units, employees may be too ambitious and thus more careless. This may result in occupational accidents or the production of defective products. Therefore, management has a crucial role to avoid such cases in the workplace in such a competitive environment.

There are two main applications of the piece based system; money accord and time accord. Under money accord approach, units that an employee can produce under normal conditions are initially calculated. Then, the hourly payment is decided. Thus, the payment per unit is determined. But under time accord approach, time required for the production of a unit is important. This is called accord time. Also, accord factor is calculated and then the gross wage per month is determined.

Premium based system is another way for determination of labor costs. Criticisms about the disadvantages of time-based and piece based systems lead to apply for a new one, which is named the premium-based system. Under this very well-known system employee is paid a basic wage and premium for his/her efficient work. In any case, the employee is paid a basic wage but not premium even if he/she is not able to achieve the target efficiency.

There are two main types of labor costs; direct labor costs and indirect labor costs. Direct labor costs are regulated under the account group 72 in Turkish Uniform Chart of Accounts. Indirect labor costs are accumulated in manufacturing overhead; therefore, in Turkish Uniform Chart of Accounts the account groups 73 and 74 are used for indirect labor cost. Details of the accounts are as follows;
• 720 Direct Labor Expenses
• 721 Reflection Accounts for Direct Labor Expenses
• 722 Direct Labor Wage Differences
• 723 Direct Labor Time Differences
• 730 Manufacturing Overhead (General Manufacturing Expenses)
• 740 Cost of Production of Services

Payroll is not a salary or wage. Payroll or payroll register is a process. The process includes calculating wages, withholding taxes and other deductions. Nowadays automated payroll systems are used because as determined before payroll related costs constitute a major part of the total costs and tracking them accurately is important.

An employee receives net pay, which is less than gross pay. This is because there are two main deductions from the gross pay. One is required deductions by legal enforcement, the other one is optional deductions that depend on discretionary reasons. Required deductions are mainly social security premiums and unemployment insurance premiums according to social security and tax regulations. Optional deductions i.e. private pension plans are authorized by the employer for special reasons.

Social Security Institution (SSI – SGK) requires the payment of two types of social security premiums that are;
• premiums paid by the employer and in general employer’s share of the premium is 20.5% of the gross pay, and
• premiums paid by the employee and the employee’s share is 14% of the gross pay.

Similar to social security premiums employers and employees are also required to pay unemployment insurance premiums. Unemployment insurance premium is paid to the Institution of Providing Jobs and Employees (IPJE – İŞKUR) through Social Security Institution. Employer’s share of unemployment insurance premium is 2%, and the employee’s share of unemployment insurance premium is 1%. Likewise, the employer’s share of unemployment insurance premium generates an additional cost to the employer and characterized by indirect labor cost. However, employee’s share is just a deduction from gross pay and does not generate any additional cost to the employer.

Among three types of manufacturing costs, which are direct materials, direct labor and overhead, direct labor cost occupied the largest portion for many years. However, recent developments in technology shifted this largest portion from direct labor cost to overhead costs. Because the use of technology in manufacturing resulted in a decrease in direct labor and an increase in overhead costs. The manufacturing process does not need direct labor as it used to be.

The most common way to track labor costs is keeping labor time cards for many years now. The firm assigns a card to each employee. Timecard can be a physical piece of paper. In such a case as the employee enters or leaves the firm, he/she inserts the card in the clock and that clock prints the exact time for arriving and leaving. In addition, the timecard can be a virtual record updated as the employee checks in and out and enters the job number in a computerized information system.

Idle time refers to wages paid for an unproductive time caused by several ordinary and extraordinary reasons. Idle time labor costs are regarded as indirect labor costs. In order to understand the logic behind this, it would be better to clarify the concept of idle time and the reasons for idle time. Idle time is not related to a particular product; on the contrary, it is related to ordinary and/or extraordinary circumstances. Those circumstances can be lack of orders, machine or computer breakdowns, work delays, poor scheduling, maintenance or repair of the machines and the like.