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 Costs

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 costs can be directly traced to a specific unit of production. 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 absorbtion base such as the raw material cost.

Labor Costs

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 the wage cost of a machine operator used to manufacture a component is treated as a direct 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.

Expenses

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
Manufacturing Cost Components September 17th, 2018Team

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