Unapplied Labor: Manage this Misunderstood Metric
What is Unapplied Labor?
One commonly asked question that we hear a lot is “What is unapplied labor?”
Essentially, unapplied labor is an accounting adjustment to cost of sales on a financial statement that goes into an unapplied labor account — which can be a plus or minus adjustment to the cost of sales not reflected on a repair order.
Some Straightforward Scenarios
Here are a few real-life examples of unapplied labor:
- Guarantee. A technician paid a guaranteed wage on a weekly basis who is normally paid on a flat rate scale. If the technician did not generate enough hours to meet the minimum guarantee, any wages paid to the technician between what he produced and what he was paid would be billed to unapplied labor.
- Productivity bonuses. Productivity bonuses are bonuses typically paid to technicians who have exceeded expectations regarding the generation of flat rate hours. For example: I have an agreement with the technician. We pay them $27/$28 an hour, but if that technician produces 50 or more hours, we have agreed to pay them an extra $1 or $1.50 per hour that they produced. And of course, those additional wages were not initially attributed or billed back to that repair order. Therefore, the additional wages we paid would be billed back to the unapplied labor account.
- Hourly technicians. Hourly technicians are paid based on the hours they work at an agreed upon rate. Over the course of a week, those technicians should be flagging hours against their repair orders that they're working on. If my agreement is to pay a technician a 40-hour workweek, and the technician only produced 30 hours, the additional 10 hours of wages paid to the technician would get charged back against the unapplied labor (or adjustment to cost of sales) account because I had an expense on the technician not attributed to a billed hour on a repair order.
- Adjustments in accounting. These simple adjustments happen most commonly. Somebody may have mistyped a technician’s number, so the wrong technician was paid for a job, or there was a difference between the wages for the technician who was paid for the job versus the technician who should have been paid for the job, that plus or minus adjustment would also be made in the unapplied labor account.
Why is Unapplied Labor Such an Important Metric?
Any expense that goes into your unapplied labor account affects your gross profit. It's important to measure this metric to make sure unapplied wages we are charging against unapplied labor do not become excessive and eat up profitability.
Every dealership has unapplied labor. I often see “zero” unapplied labor on financials, or it doesn't appear in our NCM composite. The challenge with this scenario is that you DO have unapplied labor, but how and where are the charges being applied?
The office manager may be making a direct adjustment in a journal entry against the cost of sale. The cost was not reflected on a repair order, thus not reflected on the financial statement, resulting in an inability to measure that metric within the dealership.
Simply put, you should be applying any additional wages or adjustments to technician payroll to the unapplied labor account, to more accurately measure labor cost of sales. Any adjustments made in the accounting office that wouldn't be reflected on a repair order would normally go into the unapplied labor account.
How to Better Manage Unapplied Labor
On any given day during a month, during a normal workday, you have what we call “work in process.” Labor work in process is a record of accrued wages that:
- Have been paid to technicians for work that they have performed on vehicles in the shop
- Have already been posted into or against the payroll account
- Are waiting to be distributed (or may have been paid) to the technicians until the repair order has been closed into the accounting system
As we expense wages payable to technicians that have not been attributed to a billed hour recorded as “work in process,” the expenses accrue in your payroll labor account. Look at the unapplied labor account as a “clean-up account” used to balance the payroll account to the work in process account at the end of the month.
You can better measure and manage the unapplied labor account by having your office manager or comptroller establish what we refer to as “memo” accounts within the unapplied labor account. That would give you a more finite ability to track the wages that we are paying and dollars of expense going into the unapplied labor account, by category.
A “best practice” guide for recommended “memo” accounts to be established within the “unapplied labor” account in the Dealer Management System (DMS):
Guarantee Wages: Any wages paid to a flat technician as part of their employment agreement to ensure that any “gap” between their recorded productive wages (billed hours) and a reasonable living wage (minimum guarantee) are fulfilled.
Productivity Bonuses: Any wages paid to a flat rate technician as a bonus for exceeding expectations of performance (normally measured by billable productive hours) during a given payroll period that were not directly billed (additional wages costed) to a repair order.
Hourly Technicians: Any wages paid to an hourly technician that were not previously accounted for as a “cost of sale” on a repair order as billed time. All hourly technicians, regardless of their level of experience as a technician, or their status (apprentice, etc.) should be flagging/recording productive hours on the work that they perform – even if on an extremely limited scale. The accrual of wages that were attributed to the production of billable hours on repair orders is an offset to their overall cost on both work in process, and in payroll on the accounting side of the DMS system. Any differences between wages paid to hourly technicians (including overtime) vs. accrued costs accounted for either on work in process or within the payroll account, should be expensed to the unapplied labor account.
Adjustments: Mistakes happen, as we all well know. We typed in the wrong technician number when booking a repair order, or we missed a decimal point when billing technician hours, or a technician was given a pay increase – but this change wasn’t communicated to the accounting office in a timely manner. Adjustments made for human error (typo) or communication (wage change) or that decimal point we missed (10.0 hours instead of 1.0 hours) will have to be corrected on the accounting side of the system if the repair order has already been closed. These adjustments are normally recorded in the “unapplied labor” account within the DMS system.
Simply put, if you can more finitely categorize your unapplied labor accounts, although you will not see these “memo” accounts on a financial statement (it will still show up as one number) you will at least now have the ability to go in to the accounting side of the system and see where those dollars went.
At the end of the day, you can’t manage what you can't measure, and every dealership has a degree of unapplied labor. The important part is knowing where it is coming from and understanding things that you can do that might influence, control, or help minimize that unapplied labor expense.
What are some resources for learning more about this topic and how to manage it?
If you want to learn more about unapplied labor and how to implement a better process in your store, we do discuss and provide training on this specific topic in both our Service Management, Financial Management, General Management, and our General Management Executive Program courses. These courses include more specific accounting best practices and provide resources to help you better “understand the numbers” that are being reported on your financial statement, and on the NCM Composites.
Unapplied Labor is only one of many misunderstood accounts and metrics that require a deeper understanding to better measure, manage and improve profitability in your stores.