There are two definitions of the standard labor rate concept, which are as follows:
- Cost basis. This is the fully-burdened cost of labor that is applied to the manufacture of a product or the provision of services. This information is used to determine the profit derived from a sale, which assumes the inclusion of all applicable costs. This cost of labor is also used to calculate the cost of ending inventory and the cost of goods sold under a standard costing system.
- Price basis. This is the price per hour that is charged to a customer for services rendered. This price is comprised of a standard profit margin, as well as the provider's cost of labor and all labor-related overhead costs (such as benefits). This information is used for service billings, as well as to set long-term product prices. Conversely, a company may create a standard labor rate that is not based in any way on underlying costs, focusing instead on the rate that the market will accept.
In both cases, there may be a number of standard labor rates, each one based on the general skill sets of the employees presumed to be engaged in the related work. If there is only a single standard labor rate, it should be based on a weighted average of the fully burdened labor costs of those employees most likely to be engaged in the related work.
The information needed to derive a standard labor rate includes:
- Employee pay rates per hour
- Shift differential pay rates per hour
- Expected overtime levels
- Expected piece rate pay per unit produced
- Benefit costs (such as medical and dental insurance) per hour
- Payroll tax percentage related to the pay per hour