Accounting Best Practices, Fifth Edition

9–2. Audit Labor Routings

The labor a company charges to each of its products is derived from a labor routing, which is an engineering estimate of the labor hours required to produce a product. Unfortunately, an inaccuracy in the labor-routing information has a major impact on a company’s profitability for two reasons. One is that the labor hours assigned to a product will be incorrect, resulting in an incorrect product cost. By itself, this is not usually a major problem, because the labor cost is not a large component of the total product cost. However, the second reason is the real problem—since the labor rate is frequently used as the primary basis upon which overhead is allocated to products, a shift in the labor rate can result in a massive change in the allocated overhead cost, which may be much larger than the underlying labor cost. Thus, an inaccurate labor routing can have a major impact on the reported cost of a product.

The best practice that addresses this problem is auditing labor routings. By doing so, one can gradually review all labor records and verify their accuracy, thereby avoiding any miscosting of products. To do so, one must enlist the help of the engineering manager, who assigns a staff person to review this information on a regular basis and make changes as needed. The accounting department can assist in the effort by comparing the labor routings of similar products to see if there are any discrepancies and bring them to the attention of the engineering ...