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Direct Labour Cost Method

The cost of direct labour incurred in the manufacture of the product is used as a base for allocation of factory overheads in this method. The formula for calculating the factory overhead rate based on labour can be put as follows:

Advantages: This method has the following advantages:

1. Factory overheads to a great extent depend upon the number of workers employed and the rate of direct wages. This method, therefore, gives satisfactory results in most cases.

2. The method is widely adopted on account of its simplicity and of accuracy.

3. Direct wages normally do not fluctuate much. Therefore, this method gives stable results.

Disadvantages: It has the following disadvantages:

1. The method is not suitable where both skilled and unskilled workers are employed. As a matter of fact the amount of works overhead is less for skilled workers in comparison to the unskilled workers and, therefore, jobs done by the unskilled workers should be charged with greater amount of factory overheads, but reverse happens in case of this method.

2. Works overhead also depend upon time. The method, therefore, does not give satisfactorily results where the workers are remunerated on piece wage system.

3. No distinction is made between manual work and machine work. The work done by machinery involves heavy factory overheads in the form of depreciation etc. which are not necessary where work is done by hand.

This method is, therefore, suitable only in cases where both labour employed and work done are of a uniform type.