Question

CISCO SYSTEMS, WALMART, TACO BELL, STARBUCKS, U-HAUL, GENERAL DYNAMICS, AND FARMER’S INSURANCE: IS DIRECT LABOR A VARIABLE COST?

The question as to whether direct labor is a variable cost is interesting from a cost estimation perspective, but it also presents an interesting ethical issue.

Direct material is always a variable cost. At the other extreme, depreciation on fixed facilities and infrastructure typically is not. What about direct labor? Here it depends on the ability and willingness of management to adjust the labor force to current needs. If management is able and willing to hire workers as needed and lay them off when activity declines, direct labor would be a variable cost. The contemporary trend at many companies seems to be in this direction. “Companies are looking first to bring in contract workers that they can quickly tap and zap without paying any benefits or severance.”* In fact, the temps have recently been the fastest-growing sector of employment. “And they aren’t accounted for as regular employees. This helps companies that use a lot of them, like Cisco Systems Inc., to drive up revenue per employee.”

“The growing use of the just-in-time workforce is not the only means by which companies are priming the productivity pump. Workers complain that many employers are taking advantage of outdated labor laws by misclassifying them as salaried-exempt so they can skirt overtime pay. Walmart, Taco Bell, Starbucks, and U-Haul, among others, have been slapped with class actions. In the case of General Dynamics Corp., this resulted in a $100 million award that is now on appeal. At Farmer’s Insurance, employees got $90 million. Some employers are so worried about the issue that they are now doing wage-and-hour audits.”

Is it ethical to “tap and zap” employees? What do you think? (For more on this issue, see Management Accounting Practice: Is Direct Labor a Variable or a Fixed Cost?, page 240.)

Answer 1

Direct labor is treated as a variable cost because workers are often paid based on the number of hours worked by them. The contract workers may be paid/offered a higher rate (than permanent workers) per hour in order to compensate them for additional benefits that regular employees enjoy (such as bonus, insurance, vacation, etc.). While it may appear ethical to hire contract workers on such terms and conditions, it may not be allowed to be treated them as temporary as per the rules/regulations/laws applicable to the specific industry. In such a case, it would be unethical for a company to "tap and zap employees". Additionally, if a company treats its workers/employees as temporary just to avoid the compensation that should actually be paid to such employees, it would be treated as illegal and unethical in the eyes of law. Simply because direct labor is treated as a variable cost, employees cannot be denied the benefits that they should be receiving as per the governing rules/regulations. Therefore, employees should be treated fairly and paid accordingly in compliance with applicable worker compensation rules to avoid any ethical issues.