Manikant sah

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Manikant Sah

The cost of a product consists of the following cost components or elements:
 Direct Material
 Direct Labor
 Direct Expenses
 Factory Overhead
 Selling and Distribution and Administrative Overhead

Material indicates principal substances used in production. Examples are: cotton, jute,
iron-ore, and silicon. The cost of material is further divided in to direct and indirect

Direct Material:
Direct materials refer to the cost of materials which become a major part of the finished
product. They are raw materials that become an integral part of the finished product and
are conveniently and economically traceable to specific units of output. Some examples of
direct materials are: raw cotton in textiles, crude oil to make diesel, steel to make
automobile bodies.

Indirect material:
These are materials which are used ancillary to manufacture and cannot be traced in to the
finished product. These form a part of manufacturing overhead.
Examples are glue, thread, nails, consumable stores, printing and stationary material

Labor is the physical or mental effort expended on the production of an item. It is the active
factor of production as against material which is a passive factor. The cost of labor further
divided into direct and indirect labor.

Direct Labor:
Direct labor is defined as the labor associated with workers who are engaged in the
production process. It the labor costs for specific work performed on a product that is
conveniently and economically traceable to end products. Direct labor is expended directly
upon the materials comprising the finished product. Examples are the labor of machine
operators and assemblers.

Indirect labor:
This includes wages paid for all labor which is not directly engaged in changing the shape
or composition of raw materials. It cannot be traced directly to the product. Lick indirect
materials, indirect labor forms part of the manufacturing overheads. Examples of indirect
labor cost are wages paid to foremen, supervisors, store-keepers, time-keepers, salaries of
office executives and the commission payable to sales representatives.

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Manikant Sah
Direct Expenses:
Direct expenses include any expenditure other than direct material and direct labor
directly incurred on a specific cost unit (product or job). Such special necessary expenses
can be identified with cost units and are charged directly to the product as part of the
prime cost.

Some examples of direct expenses are:
(a) Cost of special layout, designing or drawings;
(b) Hire of tools or equipment for a particular production or product;
(c) Maintenance costs of such equipments.

Indirect expenses:
Indirect expenses are those incurred for the business as a whole rather than for a
particular order, job or product. Examples of such expenses are rent, lighting, insurance

Overheads may be defined as the aggregate of indirect material, indirect labor and indirect
expenses. Thus, all indirect costs are overheads. These cannot be associated directly with
specific products. Hence, the amount of overhead has to be allocated and apportioned to
products and services on some reasonable basis. The synonymous term is “burden”.
Overheads may be subdivided in to following groups:
 Factory overheads.
 Administrative overheads.
 Selling and distribution overheads.

Factory Overhead:
Factory overhead also called manufacturing expenses or factory burden may be defined as
the cost of indirect materials, indirect labor and indirect expenses.
Examples of such items are lubricants, cotton waste, hand tools, works stationery.
Selling and Distribution and Administrative Overhead:
Selling and distribution overhead is also known as marketing or selling overhead.
Distribution expenses usually begin when the factory costs end. Such expenses are
generally incurred when the product is in saleable condition. It covers the cost of making
sales and delivering/dispatching products. These costs include advertising, salesmen
salaries and commissions, packing, storage, transportation, and sales administrative costs.
Administrative overhead includes costs of planning and controlling the general policies and
operations of business enterprises. Usually, all costs which cannot be.

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Manikant Sah
Fixed cost:
Fixed cost is the cost which does not change in total for a given time period despite wide
fluctuations in output or volume of activity.
Example: Rent, Property taxes, Supervising salaries, depreciation on office facilities,
advertising, insurance etc.
Fixed cost can be further classified into three types:
 Committed cost
 Managed cost
 Discretionary cost

Variable cost:
Variable costs are those costs that vary directly and proportionately with the output. There
is a constant ratio between the change in the cost and change in the level of output. Direct
materials cost and direct labor cost are the costs which are generally variable costs.
Mixed cost:
Mixed costs are made up of fixed and variable elements. They are combination of semi-
variable costs and fixed costs.
Classification of costs

Cost is the price of expenditure incurred on a produced item. The term cost refers to the
amount of resources given up in exchange for some goods and services. The term cost has
different meanings to different people, but in cost accounting, it is used in a special sense.
Cost represents an expenditure made to secure an economic benefit, generally on the uses
of resources that promise to produce revenue. The cost of the product will include all the
tangible and intangible expenses. The calculation of cost may vary from person to person.
Cost of a suit may be only the expenses up to the production of the suit for one person or it
may include selling and distribution expenses also. Without calculating the cost of the
product it is not possible to fix the price of the product.

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Manikant Sah
1. Classification on the basis of elements.
Material is the most important element to produce a product. All most 50% of the cost is
covered by raw material used to produce a product. Material is also called as tangible items
used in production e.g. wood used for furniture, cotton for clothes etc.
Further material can be divided into two parts:
Direct material: raw material that is consumed in the manufacturing process, physically
incorporated in the finished product, and can be traced out to product conveniently and
economically is called direct materials, tin-sheets for packing case.
Indirect material: it is that material which is required for production but do not become
an integral part of prodction.For example lubricant oil, fevicol, stationery etc.
After raw material labor is an important part of cost of a product. Labor plays an important
role in conversion of raw material into finished product. The reward for the human efforts
in the form of salaries and wages is calculated in the cost of a product.
Further labor can be divided into two parts.
Direct labor: Labor, which takes an active and direct part in the production, is called as
direct labor. For example wages of operator, workers, skilled labor, weavers etc.
Indirect labor: The cost of human being who do not takes direct part in production but
they help indirectly in production process called as indirect labor. For example wages of
storekeeper, director’s fee, salaries of salesman etc.
There are other so many expenses other than material and labor are there like factory rent,
office rent etc.
Further expense can be divided into two parts.
Direct expenses: these are the expenses, which are directly related to cost of the product
such as hire of special machinery etc.
Indirect expenses: these expenses are not of direct in nature but without these expenses
production cannot be completed. Like rent, rates, insurance etc.
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Manikant Sah
2. Classification of costs on the basis on the basis of the product.
Direct cost:
The expenses incurred on materials and labor, which are easily and economically traceable
to a product, service, or job are direct costs. Direct material, direct labor and some
expenses are included in direct expenses.
Indirect cost:
Indirect cost is those expenses, which are incurred on those items, which are not directly
chargeable to cost of a product. For example factory rent, wages, foremen etc.

3. Classification of cost on basis of change in the level of production.
Fixed cost:
Fixed cost is the cost, which will remain same whether there is increase or decrease in size
of production. e.g. Rent, insurance, salary etc. will remain fixed at all levels of production.
But it does not mean fixed cost remains fixed forever. It also changes after the specific level
of production.
Variable cost:
Variable cost is the cost, which varies with the level of production. Variable cost will
increase with the increase in production level. For example direct material, direct wages
4. Classification of costs on the basis of functions.
Production cost:
The production cost is the cost, which occurred on the conversion of raw material into
finished product, or we can say that it the cost incurred on the sequence of production.
Administration cost:
The cost of formulating the policies, directing he organization, and controlling the
operations, of an undertaking, which is not related to direct cost.
Selling cost. The cost incurred in promoting sales and retaining customers is called as
selling cost. It also called as marketing cost of the company.
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Manikant Sah
Distribution cost. In the present era after production distribution is also very important
task and the expenses incurred for distribution is called as distribution cost.
5. Classification of costs on the basis of controllability.
Controllable cost.
These costs are those which can be influenced by the action of a specified member of an
under taking. Controllable costs incurred in a particular responsibility center can be
influenced by the actions of the executive head of that responsibility center.
Uncontrollable cost.
These are the costs, which cannot be influenced by the action of a specified member of an
undertaking are known as uncontrollable costs. The difference in both the costs are not
very clear, and sometimes it is left to individual judgment.

6. Classification of costs on the basis of decision-making.
Shut down cost.
Some time an organization has to shutdown his production for short time period may be
because of shortage of raw material, breakdown of machinery etc.
Sunk cost.
Sometimes an organization closed down for permanent basis due to any reason. Then
capital invested minus salvage value equals to sunk cost for the business.