How to set up and monitor labour absorption in Business Central
- Alfredo Iorio
- 4 days ago
- 6 min read
Labour absorption defines how the costs associated with the time spent on manufacturing operations are applied to the finished item. In Business Central, labour absorption is set up on Work and Machine Centres, and it's divided into direct, indirect and overhead; these costs are tracked via a dedicated subsidiary ledger called Capacity Ledger Entries.
In this post, we will learn how to set up and monitor these costs in Business Central.
Understanding Capacity Ledger Entries
Capacity ledger entries in Business Central serve two purposes: the first is to measure the time spent to complete manufacturing operations, and the second is to measure costs related to such operations.
Not all phases of manufacturing operations incur costs, and the different phases of an operation result in different calculations. Let's learn what these phases are and how Business Central calculate time and costs.
Setup time: This phase is the start of the operation, and it's calculated based on the item Lot Size, or the quantity of the finished item to be produced, as stated on the production order. When a user registers Setup Time in Business Central, this signals that the operation has started, which triggers forward components setup with forward flushing and routing links. Setup time can be excluded from labour absorption.
Run Time: This phase is the core of the manufacturing operation; costs associated with run time are defined by the actual time registered and spread across the number of units produced. In some cases, run time can be costed as a fixed cost per unit and not measured in minutes or hours, like with subcontractors, which are covered later.
Wait Time: This phase adds additional time after the end of the operation, and it does not affect costs. Wait time is purely for planning purposes, and it's the only phase that can run outside a shift. For example, an operation ends at 17:30 and the Wait Time is four hours. If the late shift ends at 18:00 and the next shift at 07:30 the day after, the next operation can still start at the beginning of the next shift.
Move Time: This is the time required to move items from one area of the shopfloor to the next one. Move time does not affect costs, but, unlike Wait Time, it must happen within the shifts (we need personnel to move items).
All these phases are measured in units of time for planning purposes - from milliseconds to hours - and can be set up with different time units. For example, Setup and Move time can be defined in hours, while Run Time in Seconds.
Set up the three types of Capacity Costs
Business Central supports three separate labour absorption (capacity costs) types: Direct, Indirect and Overhead.
We set up cost types on Work or Machine Centres, where we also set up how these costs are calculated. The most common method is time, which is linked to the Unit of Measure field on the Work or Machine Centre card.
All three costs will be applied when users register time against operations where costs are calculated. For example, registering one hour of Run Time for a Work Centre set up as per the example above will result in the following:
Direct: Actual labour like shopfloor wages.
Indirect: Ancillary labour, like wages of managers and supervisors.
Overhead: Cost of energy consumed by manufacturing equipment.
Business Central also allow organisations to override the costs set up for specific operations by enabling the field Specific Costs on the Work Centre card.
When a Work Centre is set up with specific costs, users can define a cost per unit of time on the Routing Line. In this case, we don't have the same three cost types but just one: direct costs
.
In some cases, labour costs cannot be tracked by time, but by the unit. In these cases, Work and Machine Centres can be set up with a cost per unit produced.
How to track capacity for costing purposes: per unit vs per time
In most cases, labour, therefore, capacity costs are tracked by time and then allocated to the finished items produced proportionally. Occasionally, the costs of running machines or other manufacturing equipment are calculated based on the units produced. Such a scenario is supported in Business Central by enabling cost calculation per unit on the Work or Machine Centre card.
This type of calculation is not typical for costs related to running manufacturing equipment or shopfloor teams, but is very common in subcontracting operations.
Use Subcontractors to record 3rd party labour costs
Subcontracting manufacturing operations in Business Central means using a 3rd party (a vendor) to run one or more operations.
A subcontractor can be an engineer coming on-site to perform specific operations, a team, or a company that receives semi-products and ships back the finished items.
Subcontracting can even involve moving materials to a separate location based on the operations' end date and time. Business Central's planning engine can be configured to automate the creation of transfer orders to move inventory to and from a subcontractor location.
To turn a Work Centre into a Subcontractor, we must link it to a vendor.
Once a production order that contains one or more operations linked to a subcontractor is released, we use the Subcontracting Worksheet to create special Purchase Orders.
Receiving and invoicing such orders will register capacity, therefore, labour costs. Output journals are not used in this case.
Now that we understand how Business Central calculates capacity costs, we can dive deeper into the posting setup to ensure the various costs are posted to the general ledger.
Apply the correct Posting Setup
All costs related to manufacturing operations are posted to the general ledger in real time; the rules about what general ledger code will be used are defined in the General Posting Setup page.
The field General Product Posting Group on the Work Centre card serves as a mapping tool that links costs registered for specific operations to general ledgers in the company's chart of accounts.
This is how the three cost types (Direct, Indirect, and Overhead) link to the General Posting Setup page:
Cost Type | General Posting Setup |
|---|---|
Direct | Direct Costs Applied |
Indirect | Overhead Applied |
Overhead | Overhead Applied |
From this table, we can clearly see that although Business Central can calculate three costing types, the amounts posted to the general ledger will be split into two. Indirect costs and Overhead Applied will post to the same General Ledger.
General Business Posting Group: The Reason Code for labour absorption posting rules.
If we pay attention to the General Posting Setup table, we notice that the posting rules for all transactions are not simply linked to the General Product Posting Group, but a combination of this field and the General Business Posting Group:
The General Business Posting Group is essential for sales and purchase transactions because it is associated with the customer and the vendor for whom we post an invoice. nevertheless, this field can - and sometimes should - be applied to production orders.
Doing so will allow us to create complex rules so that capacity costs for the same Work Centre will post to different general ledger codes depending on the value of the General Business Posting Group on the Production Order.
You can think of this field as a "reason code" for the production order that extends the posting routine.
Understanding Accounting Rules that apply to Labour Absorption
We cannot fully understand costing until we learn the accounting rules that govern these transactions. Let's run through an example:
The shopfloor manager at Contoso US releases a production order. The team needs to register ten hours against the Inspection operation. The Work Centre setup is as follows:
Direct Unit Cost: $100.00
Indirect Cost %: 2 ($2.00)
Overhead Applied: $50.00
The costs are measured by the hour, which is $152.00 per hour.
The accounting transactions resulting from posting the Output Journal are as follows:
Dr. Work in Progress (WIP) $1520.00
Cr. Direct Costs Applied $1000.00
Cr. Overhead Applied $520.00
In accounting terms, Direct Costs Applied and Overhead Applied are used as an accrued liability, like accrued wages. When the production order status changes from Released to Finished, the balance in WIP will be rolled up into the cost of the finished item, hence the term "labour absorption" as the costs of labour are absorbed into the cost of the manufactured item. These costs will become Cost of Sales when the item is sold.
At the end of the month, a member of the accounting team - typically a cost accountant - will reverse the accrued labour costs into the P&L as wages payable, and any difference will be posted to the P&L.
Conclusion
By configuring the appropriate cost types on Work Centres and Machine Centres, distinguishing between direct, indirect, and overhead labour costs, and correctly handling the four phases of manufacturing operations, such as Setup Time, Run Time, Wait Time, and Move Time, we ensure that labour costs are absorbed accurately into produced items.
When subcontracting is involved, linking Work Centres to vendors and utilising the Subcontracting Worksheet allows these external costs to flow through the system in the same controlled manner.
All related transactions post to the Capacity Ledger Entries and, ultimately, to the general ledger in real time through the rules established in General Posting Setup. This approach provides full traceability of labour absorption, supports precise WIP valuation, minimises unexpected variances at period close, and delivers reliable cost information for production and financial reporting in Business Central.
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