How to Allocate Costs to Labor Hours

by W D Adkins, Demand Media

Businesses, such as contractors, repair shops and temp agencies, include cost of labor charges in their pricing structures. When determining a rate for labor, you have to take into account hidden costs like benefits and payroll taxes in addition to wages paid to workers. Even if you don’t have to list labor costs when billing your customers, you still need to know how to allocate costs to labor hours as part of the management of a business.


The labor cost for an employee includes compensation plus any additional expenses linked to that employee. Compensation consists of wages or salary plus employer-paid Social Security, Medicare and unemployment taxes along with workers compensation insurance. Shift differentials, incentive pay and employer contributions to health care and retirement plans are also compensation. You may need to allow for other costs, such as reimbursement for travel expenses, cost of uniforms and operating costs for a company vehicle used by an employee.

Actual Labor Hours

Most employees are paid for more hours than they actually work. For example, a worker may receive paid vacation days and sick leave. To calculate the actual wages per hour, first multiply an employee’s wage rate by the number of hours he will potentially be paid for in a year. For an employee who works 40 hours per week, this equals 2,080 hours, or 52 weeks multiplied by 40 hours. If the employee is paid $15 per hour, annual wages equal $31,200. Suppose you expect to pay for holidays, vacation time and sick time totaling 20 days, which is 160 hours per year. Subtract 160 hours from 2,080 to get 1,920 hours actually worked. Divide the annual wages by the actual labor hours to find the wages per labor hour. In this example, $31,200 divided by 1,920 hours works out to $16.25 per hour.

Labor Burden

To calculate the total labor cost per hour worked, add up all of the non-wage expenses. Suppose you pay $4,800 for payroll taxes and workers compensation insurance, plus another $4,000 for health insurance and contributions to a retirement plan. You also reimburse the employee $2,000 for using her personal vehicle in her work. Adding annual wages of $31,200 gives you a total of $42,000. Divide this total by the number of hours actually worked. For a total of 1,920 labor hours, this results in an actual cost per labor hour of $21.88. Thus, although in this example the employee’s wage rate is $15 per hour, you must allocate an additional $6.88 to find the true hourly labor cost.

Labor Rates

To set a rate for labor costs, you need to compute the average hourly labor cost for all employees. The calculation is very similar to that used to figure the true hourly labor cost for a single employee. Add up the non-wage costs and annual wages for all employees to estimate your total annual labor cost. Next, add up the estimated labor hours for a year for all employees. Divide the estimated annual labor cost by the estimated number of labor hours to find the amount you need to allocate per labor hour.

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