Management Accounting · Budget preparation

How to Prepare a Direct Labour Budget

Updated 11 October 2026 · Fact-checked

A direct labour budget shows the hours and cost of labour needed to meet the production budget. Multiply units to produce by standard hours per unit, adjust for efficiency and idle time to get hours to pay, then multiply by the hourly rate, adding any overtime premium.

Understand Labour Budget and Labour Hours

A direct labour budget is built from the production budget. Production tells you how many units must be made. The labour budget tells you how many hours of workers' time that needs, and what those hours will cost.

Start with standard hours: the hours a unit should take if workers perform at the expected level. Units to produce × standard hours per unit gives the hours of work needed. This is often called the hours required, or standard hours produced.

Real workers are not always 100% efficient, and they are not always working. Efficiency below 100% means workers take more hours than standard to do the work. Idle time is paid time when no work is done, for example because of machine breakdowns or waiting for materials. Both mean you must pay for more hours than the standard hours of work.

The budget has two stages. First, hours required for production. Second, hours to be paid, which includes allowances for efficiency and idle time. Cost is based on hours paid, not hours worked. Labour is paid for idle time.

Finally, compare hours paid with the hours available. If you need more hours than normal time provides, you may use overtime, which costs more per hour, or you may be limited by labour as a limiting factor.

Key formulas to remember

Standard hours required: Units to produce × standard hours per unit; Use units of production, not units sold. Production comes from the production budget.
Hours of active work at given efficiency: Standard hours required ÷ efficiency %; At 80% efficiency, divide by 0.80. Lower efficiency means more hours.
Hours to be paid with idle time: Hours worked ÷ (1 − idle time %); Use when idle time is a percentage of total paid hours. If idle time is a percentage of hours worked, multiply by (1 + idle %) instead. Read the wording.
Direct labour cost: Hours paid × rate per hour; Add overtime premium separately on the overtime hours only.
Overtime premium cost: Overtime hours × premium per hour; Premium is the extra above the basic rate, for example 0.5 × basic rate if time-and-a-half.

How to solve Labour Budget and Labour Hours questions

Use this order for any labour budget question. Write each line down so you can see which adjustment you have done.

1Find the units to be produced from the production budget (sales + closing inventory − opening inventory).
2Multiply by standard hours per unit to get the standard hours required.
3Adjust for efficiency by dividing by the efficiency percentage, if given.
4Adjust for idle time to get the hours to be paid. Check whether idle time is a percentage of total paid hours or of hours worked.
5Compare hours paid with normal hours available. Any excess is overtime, if overtime is allowed.
6Calculate cost: basic hours × basic rate, plus overtime hours × overtime rate (or premium on the extra hours).
7Check the answer asked for: hours, cost, or both, and for which product or period.

Quickest way: Hours chain, then rate

When to use it: Use in the objective test when the question gives production, hours per unit, efficiency and idle time, and asks for hours or cost.

Write the chain: units × hours per unit ÷ efficiency ÷ (1 − idle %).
Calculate once on your calculator, keeping full decimals until the end.
Multiply by the hourly rate for cost.
For overtime, find the hours above normal time and add the premium only on those hours.
Compare your result with the options. Wrong options often come from skipping one adjustment.

Common mistakes in Labour Budget and Labour Hours

Multiplying by efficiency instead of dividing.
Students think 80% efficiency should reduce the number.
Fix: Lower efficiency means more hours. Divide by 0.80. Check that your answer is larger than the standard hours.
Using sales units instead of production units.
The sales figure is the first number in the question.
Fix: Always calculate production first: sales + closing inventory − opening inventory.
Paying only for hours worked and ignoring idle time.
Idle time feels like it is not labour.
Fix: Idle time is paid. Cost uses total hours paid, including idle hours.
Treating idle time as a percentage of the wrong base.
Wording such as '10% of hours paid' and '10% of hours worked' looks similar.
Fix: If 10% of paid hours is idle, divide worked hours by 0.90. If idle time is 10% on top of worked hours, multiply by 1.10.
Applying the overtime rate to all hours.
Students see the overtime rate and use it everywhere.
Fix: Pay normal hours at the basic rate. Only hours above normal time get the overtime rate or premium.

Worked examples

Example 1

A company budgets to produce 4,000 units. Each unit needs 2.5 standard labour hours. Workers are expected to work at 80% efficiency. Idle time is expected to be 10% of total hours paid. The wage rate is $12 per hour. Calculate the budgeted direct labour cost.

Show the solution

Standard hours required = 4,000 × 2.5 = 10,000 hours.
Adjust for efficiency: 10,000 ÷ 0.80 = 12,500 hours worked.
Idle time is 10% of hours paid, so hours worked are 90% of hours paid.
Hours paid = 12,500 ÷ 0.90 = 13,888.89 hours (rounded).
Cost = 13,888.89 × $12 = $166,667 (rounded).

Answer: Hours to be paid are about 13,889 and the budgeted direct labour cost is about $166,667.

Example 2

A business budgets sales of 1,800 units. Opening inventory is 200 units and closing inventory is to be 300 units. Each unit needs 3 hours of labour at 100% efficiency. Normal time available is 5,000 hours at $10 per hour. Overtime is paid at time-and-a-half. Calculate the total budgeted labour cost.

Show the solution

Production = 1,800 + 300 − 200 = 1,900 units.
Hours required = 1,900 × 3 = 5,700 hours.
Normal hours = 5,000, so overtime hours = 5,700 − 5,000 = 700.
Normal cost = 5,000 × $10 = $50,000.
Overtime rate = $10 × 1.5 = $15 per hour, so overtime cost = 700 × $15 = $10,500.
Total cost = $50,000 + $10,500 = $60,500.

Answer: Total budgeted labour cost is $60,500, which includes an overtime premium of $3,500.

Exam tips

Write the hours chain in order and tick off each adjustment. Most wrong options are one missed step.
Read the idle time wording twice: percentage of hours paid or of hours worked.
Number entry questions often want hours, not cost. Check the unit asked for and any rounding instruction.
If the question mentions a labour shortage, think limiting factor and check if overtime is allowed before using it.
For multiple response questions, test each statement separately: lower efficiency raises hours, idle time raises cost, overtime raises the rate.

Practice questions from Budget preparation

Labour Budget and Labour Hours: frequently asked questions

What is the difference between hours required and hours paid?

Hours required are the standard hours the production needs at full efficiency. Hours paid include extra time for lower efficiency and idle time. You pay for hours paid.

Does idle time affect the labour budget?

Yes. Workers are paid for idle time, so it raises the hours paid and the cost. It does not add any extra output.

How do I calculate overtime in a labour budget?

Find the hours needed above normal time available. Pay normal hours at the basic rate and the extra hours at the overtime rate. Or add the premium only for the overtime hours.

Where does the labour budget start from?

It starts from the production budget, not the sales budget. Production units depend on sales and changes in finished goods inventory.