CLASSIFICATION OF MANUFACTURING COSTS


CLASSIFICATION OF MANUFACTURING COSTS

The three elements of production costs are materials, labour and expenses.  Each one may be categorized as either direct or indirect cost.

Direct costs are those costs which may be identified with the product and therefore can be included directly in the cost of the product. These are costs that can conveniently and easily be traced to a particular product, department or any other object that costs are accumulated.  Examples are:

(a) Direct materials - all materials that form an integral part of the finished product, like leather for shoes, wood for furniture, etc.

(b) Direct labour - it is labour applied directly on the raw materials, in order to convert these into finished product. Like the wages paid to factory workers or machine operators engaged in the production process are classified under this category.

(c) Direct expenses - are those specifically attributed to the product, like the royalty paid to an inventor or patent - holder of the product.

All the above direct costs put together are termed "Prime Costs" of the product.

Indirect cost or overhead are all other costs incurred by the manufacturing firm in its business operations.  Examples are:

(a) Indirect materials - these are materials needed for the completion of the product but whose consumption is quite small or the process of identifying them to a certain product is quite complicated.  Glue, thread, nails and similar items belong to this category.

(b) Indirect labour - the salaries and wages paid to employees and workers who are indirectly involved with the product like the foremen, shop supervisor, storekeeper, etc.

(c) Indirect expenses - all other costs besides indirect materials, indirect labour and direct costs are usually classified in this category.  These include rent, insurance, electricity, repairs, etc.

Costs may be further classified according to the functions for which they are incurred.  Thus, costs may be grouped together as:

(a) Manufacturing costs - all direct and indirect costs incurred in the production process.  Also known as factory costs or works costs.

(b) Selling and Distribution costs - these are costs incurred in marketing the product.  On occasion they may be shown separately as Selling costs which include: advertising, salaries of salesmen, commissions, etc. and Distribution costs which include: transportation costs, depreciation of vehicles, salaries of drivers, etc.

(c) Administration costs - these are general operating costs incurred in running the business which include office salaries, telephone, insurance, rent, etc.

(d) Financial costs - these are costs arising from financial decisions and transactions like interest on loans, bank charges, interest on debentures or bonds, discount allowed to customers, etc.  When these costs are few and relatively small, they are sometimes included under administration costs.

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