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COST ELEMENTS

Introduction One of the basic purposes of a system of cost accounting is to determine the cost of products (or services). This information is required, inter alia, for estimating the cost of goods sold and valuing inventories. In a manufacturing enterprise the total cost may be divided into two broad categories: manufacturing costs and non manufacturing costs. !ost accounting has traditionally been concerned with manufacturing costs. Only in recent years has the analysis of non manufacturing costs received more attention. "owever, the principal focus of cost accounting continues to be on manufacturing costs. The reasons for this are: (i) The general accounting practice is to include only manufacturing costs in the valuation of inventories# and (ii) $anufacturing activity is more standardi%ed and routinised compared to non manufacturing activities (li&e general administration, mar&eting and research and development). In activity based costing (which states that products consume activities and activities consume resources), cost element is the cost of a resource or input consumed by an activity. !ost element is a specific function (or a group of functions) which is considered a specific entity for the purpose of estimating, controlling, and reporting costs. There are three elements of costs which include direct material, direct labour, and factory' production overhead.

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plastic parts and paint etc. Other direct materials would include. Illustration 2: Examples of direct material costs Examples . The table below provides a few e+amples. Direct Materials (irect materials cost is the cost of materials which can be identified with. *or instance. monitors. the more parts the company has to acquire. )ariable costs change in proportion to production.1. etc. in&.ublishing company -utomobile manufacturer !omputer manufacturer Direct Materials . etc. *rom the table we can observe that direct materials are the integral part and a significant portion of finished goods. Therefore. and allocated to.aper. The more valves are produced. cost centres or cost units. (irect materials always have a variable nature. (irect material is that material which becomes a part of the product. boo& covers. etc Tires. (irect materials are raw materials that become an integral part of the finished goods. parts have a variable nature# the amount of raw materials bought and used changes in direct proportion to amount of valves created. (ifferent manufacturing companies will have different direct material costs depending on the types of finished goods they produce. 2|Page . (irect materials should be distinguished from indirect materials (part of overhead costs). for e+ample. automobile metal parts. "ard drives. a company purchases metal parts (raw material) to produce valves.

when added together. indirect wages. move raw materials from the warehouse to equipment. and indirect e+penses incurred in the factory from the receipt of the order until its completion ready for dispatch. the cost of wages of employees who are directly involved in converting raw materials into finished goods. . In most situations the amount of direct labor required is directly correlated with the amount of finished goods produced. The more valves are to be produced. (irect materials and direct labor are called prime costs because they are directly (physically. wages and related benefits of employees who operate machinery to produce valves represent direct labor costs for a company. These employees are directly involved in the production process and cost of their remuneration and benefits represents direct labor. *or e+ample. /primarily/) associated with the production of the finished good. (irect labor is the cost of wages to be paid to individuals who wor& on specific products or in other words. conformation or composition of the product. and so on. -lmost any production plant or factory requires employees to operate equipment. etc. Direct La or (irect wages (labour costs) are the wages which can be identified with and allocated to cost centres and cost units. represent the prime cost. assemble. 3|Page . *actory overhead includes all indirect material cost. paint. the more employees will be required to operate machinery. (irect materials and direct labor. "actor# O$er%ead *actory (or production) overhead is any manufacturing cost that is not direct materials or direct labor.sually direct labor is a variable cost.2. !. (irect labour is the labour e+pended in altering the condition.

pac&age bo+es. 4|Page . depending on whether overhead changes in direct proportion with production levels. or b) a minor part of the finished goods to be economically traced to the finished good or have a very small physical association with the finished product. a manufacturing company may treat the following costs as indirect materials: oil lubricants and light bulbs used in manufacturing equipment.roperty ta+es . wrenches.roperty insurance 3alaries for non production employees Indirect 2abor Indirect materials are materials that are# a) not an integral (physical) part of the finished goods. etc. The table below provides a few e+amples. Other companies will have different types of indirect materials depending on their manufacturing processes. *or e+ample.• • • Indirect materials Indirect wages Indirect e+penses *actory overhead can have variable or fi+ed nature. The following are some e+amples of factory overhead costs: Illustration !: Examples of fixed and $aria le factor# o$er%ead costs &aria le "actor# O$er%ead Examples • 0lectricity • • • • "ixed "actor# O$er%ead Examples • (epreciation • • • "eating 1ater Indirect $aterials .

etc. indirect materials are an insignificant portion or not an integral part of the finished goods. represent the con$ersion cost. maintenance people. are considered indirect labor. screwdrivers. -s can be seen from the table. supplies room supervisors. drill bits etc. direct labor. -ssembly line lubricants. printing press lubricants. when added together. etc. but do not wor& on a specific product. *or e+ample. wages of custodians.ublishing company -utomobile manufacturer !omputer manufacturer Indirect Materials 4lue.Illustration ': Examples of indirect materials cost (o$er%ead cost) Examples . (irect labor and factory overhead are called conversion costs because they are involved in converting raw materials into finished goods. 5|Page . overhead. prime cost and conversion cost. etc *actory light bulbs. polishers. Indirect la or is the cost of production employees who are involved in the manufacturing process. Illustration below shows relationship between direct materials. (irect labor and factory overhead.

een direct materials.Illustration *: +elations%ip et.prime cost and con$ersion cost . 6|Page . indirect wages and indirect e+penses incurred in the direction.direct la or.dministration o$er%ead: -dministration overhead includes all indirect materials cost.o$er%ead. control and administration of an underta&ing. indirect wages and indirect e+penses incurred in promoting sales and retaining customers. Distri ution o$er%ead: (istribution overhead includes all indirect material cost. Sellin/ o$er%ead: 3elling overhead includes all indirect materials cost. indirect wages and indirect e+penses incurred with ma&ing the pac&ed product available for dispatch and ends with ma&ing the reconditioned returned empty pac&ages available for reuse.

5on manufacturing costs categori%ed into four components: (i) (ii) (iii) (iv) (istribution costs. etc. There is a reali%ation that these costs need to be analy%ed more penetratingly for purposes of planning and control. improving e+isting products or processes. term loans. sales promotion. ) +esearc% and De$elopmental Costs These are incurred for developing new products or processes. 7|Page . distribution. 6epresenting outlays on scientific research and development efforts not for production and mar&eting activities these costs are assuming greater significance with rapid changes in technology. and -dministrative costs.Non0manufacturin/ Costs !ost accountants are now bestowing attention to non manufacturing costs as well. a) Distri ution Costs These include costs incurred in mar&eting related activities such as selling. c) "inancial Costs The principal financial cost is the interest on wor&ing capital advance. and searching for new &nowledge. *inancial costs. Other financial costs that may be incurred by a business are commitment fee and ban& commission. and debentures. 6esearch and development costs. transportation advertising.

general accounting costs. directors7 fees.d) .dministrati$e Costs This category includes the cost of general administration and other costs which logically do not fit into other classifications. and head office e+penses 8|Page . public relations e+pense. Important items included under this head are: salaries of top managerial personnel. audit and legal fees.

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