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Manufacturing Cost

What is a manufacturing
cost
Manufacturing costis the sum of costs of
all resources consumed in the process of
making a product. Themanufacturing
costis classified into three categories:
direct materialscost, direct laborcostand
manufacturingoverhead (factory
overheads).
Manufacturing costs are the costs necessary
to convert raw materials into products

Manufacturing or Nonmanufacturing?
The key to understanding if a cost is
manufacturing or non-manufacturing
is to think about where in the process
the cost occurs. If the cost occurs in
the factory while being produced, it is
considered a manufacturing cost. If
the cost occurs after the product is
produced or outside the factory, it is
considered a non-manufacturing cost.

Product and Period Costs


All manufacturing costs are product costs.
Examplesare raw material, labor, factory depreciation, fuel and
packaging costs.
All non-manufacturing costs are period costs.
(A period cost is charged to expensein the period incurred. This type
of cost is not included within the cost of goods sold on the income
statement.
Instead, it is typically included within the selling and administrative
expenses section of the income statement).
Examples are advertising expense, selling expenses, office rent,
sales commissions, general and administrative expense, office
supplies, office depreciation, legal and research and development
costs.

Product and Period Costs


Only product costs are
categorized as direct or indirect. The
labels of direct and indirect pertain
to the relationship a product cost
has with a product.

Since period costs have no


relationship with products, they are
never labeled as direct or indirect.

Overheads
Indirect
Materia
l

Indirect
Labour

Indirect
Expens
es

Overhea
ds

Overheads or indirect
costs are incurred
not just for a
particular product
unit or cost center,
but for a number of
cost units or cost
centers. Therefore,
they cannot be
identified with a
particular cost
center or cost unit.

Classification Of Overheads
Classification Of Overheads Based On Function
* Manufacturing Overheads
* Non-manufacturing overheads
Classification Of Overheads Based On Behavior
* Fixed Overheads
* Variable Overheads
* Semi-variable Overheads
Classification Of Overheads Based On Elements
* Indirect Materials
* Indirect labor (Wages)
Classification Of Overheads Based On Control
* Controllable Overheads
* Uncontrollable Overheads

Allocation and Apportionment of


Overheads
Allocation of overheads is the process of charging
overhead costs to a particular department or cost center.
It is the allotment or assignment of an overhead cost to a
particular cost unit.
If the overhead cost is associated with a single department
or cost center, the whole amount is charged or distributed
among the units of output of that particular department.
For example, the whole amount of repair and maintenance
expenses for a machine is charged or allocated to that
department where the machine has been installed.

Allocation and Apportionment of


Overheads
Distribution of an overhead cost to several
departments or cost centers is known as
apportionment of overheads.
If a given cost is common to two or more
departments or cost centers, such cost should be
apportioned or divided among these departments
on an equitable basis.
For example, the amount of factory rent should be
apportioned to all the departments. rent charges to
be distributed according to the floor space occupied
by each department.

Bases of apportionment
Expenses

Bases

Factory rent

Square feet

Power

Kilowatt hour (KWH)

Indirect material

Direct material

Indirect wages

Direct wages

Repairs to plant

Plant value

Depreciation

Plant value

Lightings

Light points

Supervision

Number of employees

Fire insurance of stock

Stock value

Fire insurance of capital assets

Value of capital assets

Labour welfare expenses

Number of employees

General factory overheads

Labour hours/direct wages

General Operating Expenses


Expenditures related to the day-today operations of a business.
General and administrative expenses
pertain to operation expenses rather
that to expenses that can be directly
related to the production of any
goods or services. General and
administrative expenses include rent,
utilities, insurance and managerial
salaries.

Target Costing
A target cost is the allowable amount
of cost that can be incurred on a
product and still earn the required
profit from that product. It is a
market driven cost that is computed
before a product is produced.
80-90% of the life cycle cost is
determined at the design phase of
the product
Target costing was invented by

Target Costing
Target Costing is defined as a cost
management tool for reducing the
overall cost of a product over its
entire life-cycle with the help of
production, engineering, research
and design.

Target Costing Objectives


To identify the cost at which the
product must be manufactured if it's
to earn its target profit margin at its
expected or target selling price.
To decompose the production
process and then to set cost targets
for each product element.

Target Costing
TARGET COSTING
Target costing is very much a
marketing approach to costing. The
Chartered Institute of Marketing
defines marketing as:
The management process
responsible for identifying,
anticipating and satisfying customer
requirements profitably

Target Costing
In marketing, customers rule, and marketing departments
attempt to find answers to the following questions:
Are customers homogeneous or can we identify different
segments within the market?
What features does each market segment want in the
product?
What price are customers willing to pay?
To what competitor products or services are customers
comparing ours?
How will we advertise and distribute our products? (There
are costs associated with those activities too.)

Target Costing
Of course, there will probably be a range of products and
prices, but the company cannot dictate to the market,
customers or competitors. There are powerful constraints on
the product and its price and the company has to make the
required product, sell it at an acceptable and competitive
price and, at the same time, make a profit. If the profit is
going to be adequate, the costs have to be sufficiently low.
Therefore, instead of starting with the cost and
working to the selling price by adding on the
expected margin, target costing will start with the
selling price of a particular product and work back to
the cost by removing the profit element. This means
that the company has to find ways of not exceeding that
cost.

Target Costing
For example, if a company normally
expects a mark-up on cost of 50%
and estimates that a new product will
sell successfully at a price of $12,
then the maximum cost of
production should be $8:
Cost + Mark-up = Selling
price
100% 50% 150%
$8 $4 $12

Target Costing
An emphasis on the planning and
design stage. This becomes very
important to the cost of the product
because if something is designed
such that it is needlessly expensive
to make, it does not matter how
efficient the production process is, it
will always be a struggle to make
satisfactory profits.

Factors to be considered for Design


& planning a product:
Here are some of the decisions, made at the design
stage, which can affect the cost of a product:

the features of the product


how to avoid over design
the number of components needed
whether the components are standard or specialized
the complexity of machining and construction
where the product can be made
what to make in-house and what to sub-contract
the quality of the product
the batch size in which the product can be made

Target Costing
Activity-based costing can also play an important part in target
costing. By understanding the cost drivers (cost causers) a
company can better control its costs.
For example, costs could be driven down by increasing batch
size, or reducing the number of components that have to be
handled by stores.
The concept of value engineering (or value analysis) can be
important here. Value engineeringaims to reduce costs by
identifying those parts of a product or service which do
not add value where value is made up of both:
use value (the ability of the product or service to do
what it sets out to do its function) and
esteem value (the status that ownership or use confers).

Value Engineering:
The concept of value engineering (or value
analysis) can be important here.
Value engineeringaims to reduce costs
by identifying those parts of a product or
service which do not add value where
value is made up of both:
use value (the ability of the product or
service to do what it sets out to do its
function) and
esteem value (the status that ownership
or use confers).

Target Costing
For example, if you are selling
perfume, the design of its packaging
is important. The perfume could be
held in a plain glass (or plastic)
bottle, and although that would not
damage the use value of the product,
it would damage the esteem value.
The company would be unwise to try
to reduce costs by economizing too
much on packaging.

Target Costing
Similarly, if a company is trying to reduce the costs
of manufacturing a car, there might be many
components that could be satisfactorily replaced
by cheaper or simpler ones without damaging
either use or esteem values.
Tube less tyres can be replaced with normal tyres.
However, there will be some components that are
vital to use value (perhaps elements of the
suspension system) and others which endow the
product with esteem value (the quality of the paint
and the upholstery).

Product life cycle costing:


As mentioned above, target costing places great
emphasis on controlling costs by good product
design and production planning, but those upfront
activities also cause costs. There might be other
costs incurred after a product is sold such as
warranty costs and plant decommissioning.
This is the concept of life cycle costing,
When seeking to make a profit on a product it is
essential that the total revenue arising from the
product exceeds total costs, whether these costs
are incurred before, during or after the product is
produced.

tified as:

The cost phases of a product can be identified as:

Phase

Examples of types of cost

Design

Research, development, design and


tooling

Manufacture

Material, labour, overheads, machine set


up, inventory, training, production
machine maintenance and depreciation

Operation

Distribution, advertising and warranty


claims

End of life

Environmental clean-up, disposal and


decommissioning

Product life cycle cost:


Many costs will be linked.
For example, more attention to
design can reduce manufacturing
and warranty costs.
More attention to training can reduce
machine maintenance costs.
More attention to waste disposal
during manufacturing can reduce
end-of life costs.

Typically, the following pattern of costs committed and costs


incurred is observed:

Product life cycle costing:


The diagram shows that by the end
of the design phase approximately
80% of costs are committed. For
example, the design will largely
dictate material, labour and machine
costs.

Prime Costs
Particulars

Amount

Opening Stock

xxx

(+) Purchases

xxx

(-) Closing Stock

(xxx)

Amount

Direct Materials
Consumed

XXX

Add: Direct Labour

XXX

Add: Direct Expenses

XXX

PRIME COST

XXXX

Cost Sheet
Cost sheet is a statement prepared to
show the various elements of costs, like
prime cost, factory cost of production
and total cost. It is prepared at regular
intervals, for example, weekly, monthly
quarterly, yearly.
In some cases comparative figures of various
periods are also shown in the cost sheet so
that assessment can be made about the
progress of a business.

Cost Sheet
Particulars

Amount

Direct Material

XX

Direct Labour

XX

Direct Expenses

XX
PRIME COST XXX

Factory Overheads

XX
FACTORY COST XXX

Administrative overhead

XX
COST OF PRODUCTION XXX

Selling and Distribution overheads

XX
COST OF SALES XXX

Profit

XX
SALES XXXX

Thank You

CA Pooja
Shrivastava