Manufacturing Cost Components

Manufacturing costs or factory costs are those costs which relate to the manufacture of a product and consist of three basic manufacturing cost components which are materials, labor, and expenses.

Material Manufacturing Cost Components

The first of the manufacturing cost components is materials which includes all raw materials and consumables used in the manufacture of a product.

The distinction here between raw materials and consumables is that raw materials are part of the finished product whereas consumables are used during the manufacturing process and are not physically part of the final product. For example the production of a component might include the cost of raw materials such as steel, plastic and glue together with the cost of consumables such as machinery lubricating oil.

 

Materials can be further divided into direct and indirect materials.

Direct Material Cost

Direct material cost is the cost of all the identifiable materials used in the manufacture of a product. To be identifiable, the materials must be easily tracked, measured and allocated to a unit product for them to be classified as a direct material cost, if not then they are termed an indirect material cost. In the above example the steel and plastic used in the manufacture of the component are direct material costs.

Indirect Material Cost

Indirect material costs are those which cannot be directly traced to a specific unit of production and are absorbed into the product manufacturing cost using an appropriate absorption base.

In the example above it would be impractical to trace the cost of the glue used to a specific unit of production. The glue is therefore treated as an indirect material cost and absorbed into the manufacturing cost using an absorption base such as the raw material cost.

Labor Manufacturing Cost Components

Labor is the second of the manufacturing cost components and as with materials can be divided into direct and indirect labor costs.

Direct Labor Cost

Direct labor cost is the gross wage cost of all the labor which can be directly traced to a specific unit of production. For example, if a piece of furniture is being made, then the wage cost of the person producing the furniture would be a direct labor cost.

The labor included must relate to those employees who are directly working on the item being produced. The labor must be easily tracked, measured and allocated to a unit product for it to be classified as a direct labor cost, if not then the cost is termed an indirect labor cost.

Indirect Labor Cost

Indirect labor costs are those which cannot be directly traced to a specific unit of production and are absorbed into the product manufacturing cost using an appropriate absorption base.

The wage cost of a factory manager for example cannot be directly traced to a specific unit of production. The cost is treated as an indirect cost and absorbed into the product cost using an absorption base such as direct labor hours.

Expense Manufacturing Cost Components

Expenses cover any other costs not included under the material or labor manufacturing cost components. Expenses can be divided into direct and indirect expenses.

Direct Expenses

Direct expenses can be directly traced to a specific unit of production. For example material carriage inwards costs or royalty costs can be treated as direct expenses.

Indirect Expenses

Indirect expenses are those which cannot be directly traced to a specific unit of production and are absorbed into the product manufacturing cost using an appropriate absorption base.

For example the energy costs required to operate a factory cannot be directly traced to a specific unit of production. The cost is treated as an indirect cost and absorbed into the product cost using an absorption base such as machine hours.

It should be noted that selling and general and administration costs are not part of manufacturing costs.

Manufacturing Cost Components Terms

Using the manufacturing cost components described above various commonly used terms can be defined in relation to manufacturing costs.

manufacturing cost components
 

Prime cost

Prime cost is the total of all the direct costs of manufacturing a product.

Prime cost = Direct materials + Direct labor + Direct expenses

Manufacturing Overhead

Manufacturing overhead is the total of all the indirect costs of manufacturing a product.

Manufacturing overhead = Indirect materials + Indirect labor + Indirect expenses

Conversion Cost

Conversion cost is the total of all the manufacturing cost components described above other than the direct material costs. It is the cost of converting the direct materials into a finished product.

Conversion cost = Direct labor + Direct expenses + Indirect materials + Indirect labor + Indirect expenses
Last modified April 30th, 2019 by Michael Brown

About the Author

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.

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