The Need for Time Tracking

Three types of costs are incurred by any organization: direct materials, overhead, and direct labor. Historically, the largest of these three types of cost was either direct materials or labor. This necessitated the creation of elaborate tracking mechanisms for these two cost categories, while overhead costs were largely ignored. Since the advent of technology advances, however, the cost of overhead has skyrocketed, while direct labor costs have shrunk. As a result, much of the accounting literature has advocated the complete elimination of direct labor cost tracking, on the grounds that the tracking mechanism is much too expensive in relation to the amount of direct labor cost that is now incurred.

In reality, a company's specific circumstances may still require the use of detailed direct labor tracking. This is certainly the case if the proportion of direct labor to total company costs remains high, such as 30 percent or more of total company costs. Given this large percentage, it is crucial that management know the variances that are being incurred and how to reduce them. Another case is when a company operates in such a competitive industry that shifts in costs of as little as 1 percent will have a drastic impact on overall profitability. Finally, the decision to use a detailed labor-tracking mechanism can be driven less by the total direct labor cost and more by the level of efficiency of the tracking system. For example, if a company's data-tracking costs reflect the relationship to the proportions of total company costs noted in Exhibit 2.1, then there is a strong need to reduce the labor-tracking system:

In the exhibit, the cost of direct labor is very low, while the cost of collecting all associated data is much higher than for the other two types of costs, even when they are combined. The proportions shown here are quite common. If a company is in this situation, then the data-tracking system for direct labor is probably not worth the cost of administration. That said, if this data-tracking system can be made more efficient, perhaps with the data collection methods described in the next section, then it may still be worthwhile to use a reasonably detailed timekeeping system.

In short, it makes sense to employ a relatively detailed time-tracking system for direct labor if the proportion of total company costs is heavily skewed in favor of direct labor costs, profit pressures are high, or the cost of the timekeeping system is relatively low in proportion to the amount of direct labor cost incurred.