And then there were two…

Dec 24, 2014

The traditional cost accounting theory typically breaks cost to be recovered into three general categories, materials and all the costs associated with materials, labor and all its associated cost, and then overhead. Much of what I learned in college and what I see in practice today still holds that those three components make up the body of costs to be recovered in a costing system.

However, recent experiences have shown that those three categories are more and more being turned into two categories. This is due, simply to automation and the diminishing focus of labor as a significant factor in the cost structure. In earlier and different manufacturing times, labor could sometimes be as much as 20% of cost of goods sold and in some cases even more. If labor represents that large of a segment of the costs, then it is certainly worth the additional effort to manage it and provide insight as to how to be more efficient.

However, as productivity gains became more and more important to be competitive in the world market; American manufacturers had to turn to more and more automation, and use every possible technological advantage to remain competitive in the world market. As a result, more and more manually controlled operations have now become machine controlled as automation and technology has taken over more of the duties that were once simply controlled by direct labor.

It is common for us to see businesses today where direct labor is being recovered as part of the machine rate for fixed overhead, which thereby reduces the cost categories to be recovered to two: material and overhead.

Some businesses, for a variety of reasons, feel it is necessary to have variance reporting on the labor component even though they are recovering it as part of fixed overhead. I suspect it has to do with the fact that labor is still viewed as a highly manageable cost that can be manipulated and therefore is worth the additional effort to control it even though it’s in a machine controlled environment. However, it has been my experience in more than one occasion that labor is so embedded into the machine process that a separate productivity measure is almost meaningless. That is to say if the machine is working properly, then productivity will be measured on machine output and labor crew sizes. These environments are strictly controlled by machine operations and it is not possible to have much larger or smaller productivity gains without fundamentally changing the machine process.

It certainly seems to me that future generations will likely consider labor as one more component of fixed overhead and therefore not worth substantially greater effort to manage than is any other fixed overhead.

Categories: Cost Accounting