How to calculate actual labor cost of a project?

2021-09-03

Project labor cost is an important part of project total cost.  For non-material based production projects (e.g., software development, system implementation projects), project labor cost is often larger than all other types of project cost added together).

Project labor cost refers to the salaries and wages paid to project team members involved in the project work (e.g., creation of a specific product in a project or in performing a service in a project). The work performed must be related to the specific project activities. For a project that provides services to its customers, the project actual labor is the work performed by the project team members who provide the service directly to the customers, such as auditors, lawyers, and consultants.
 
How to Measure Project Actual Labor Cost

Project actual labor cost includes the cost of working hours according to the project plan, as well as the overtime hours worked. It also includes related payroll taxes and expenses such as social security, medical benefit and worker’s employment insurance etc.  Most companies establish a standard rate per hour or per day that gives an estimate of what they expect to be the project labor cost in normal conditions for different types of labors (e.g., senior architect, senior engineer, engineer).

Using Project Labor Cost to Allocate Overheads

Accounting rules provide that companies may use direct labor as a cost driver to allocate overhead expenses to the production process. Overhead costs refer to indirect costs that cannot be connected to a specific final product. However, such costs are required in the production process of goods and must, therefore, be added to the overall cost of the product. The costs are allocated to the final product using a cost driver.

The easiest way to calculate the cost driver is to divide the total overhead costs by the direct labor costs. Direct labor cost can be broken down further to the number of employees required to create a specific product in a project or the number of man-hours utilized in a project. For example, if the ratio of overhead costs to direct labor hours is ￥50 per man-hour, the company would allocate ￥50 of overhead costs per man- hour to the project.

How to Calculate Direct Labor Cost per Man-day

The amount incurred as direct labor cost depends on how efficiently the project team members produced project deliverables. Usually, companies calculate a planned direct labor cost against which to compare their actual direct labor costs. Here is how to calculate direct labor cost per man-day:

1.    Calculate the direct labor cost per man-hour (labor charge rate)

First, calculate the direct labor cost per man-hour that factors in the fringe benefits and other direct labor cost related overheads. The direct labor cost per man-hour is obtained by dividing the value of salaries, fringe benefits and taxes by the number of hours worked in the project.

2.    Calculate the number of direct labor hours of a project

The number of direct labor hours are the amount of efforts (number of man-hours) needed to produce the deliverable for the project.

3. Calculate the actual labor cost of a project

The actual labor cost of a project is obtained by multiplying the number of direct labor hours of the project by the labor charge rate.

Final Words

Capturing number of direct labor hours of project activities is best using project management and timesheet software such as 8Manage PM.  After the number of direct labor hours of a project is captured, the system can automatically calculate the actual labor cost of a project.