In any business it is prudent to ascertain the costs that are related to making a product. This is beneficial in the setting of prices, which involves; working out what mark up to use in order to generate a profit. The three main concepts that are important regarding the basic product cost in manufacturing are; direct materials, direct labour and manufacturing overheads.
Direct materials are a major component used in the making of a product, the cost of this can be easily worked out in relation to the end product. According to Fundamentals of Accounting (2020), identification of direct materials in the product is measurable and can be charged directly to the product. An example of a direct material is flour that is used in the production of bread. A number of concepts can be classified as direct materials. Raw materials can be classified as direct materials; for instance, tomatoes in the making of tomato sauce or wheat in the making of making flour. Specific materials that are purchased for processes or particular jobs; an example is the part that connects the wheel to the car. Pieces of components are also direct materials; these parts help make the product complete, and example is batteries for cars and tyres for motor bikes.
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Edwards & Hermanson (N.D), states that direct labour is a cost that is directly related to the production of a specific product, work order or cost center. Direct labour in the manufacturing of a product is the labour undertaken by the crew that makes the products. Some of these include; painters, people that assemble the products, machine operators, delivery people, production managers and quality control checkers. The costs that are related to labour costs include; wages for normal hours, overtime or extra time that is worked by the production crew. These costs arise from the labour that is used to produce a finished product. Fringe benefits vary from company to company, some of these are; paid vacations, employee benefits and taxes on payroll. These costs can cause a significant increase in the direct labour rate. Certain companies classify these benefits as direct labour costs whilst others classify some of them as indirect or overheads.
Manufacturing overhead costs are all the costs that are not directly related to the manufacturing of a product. According to Edwards & Hermanson (N.D), overhead manufacturing costs are also known as factory burden, factory overhead and factory indirect costs. These overhead costs are incurred in the process of production but not directly related. They can not be linked specifically to the production of the finished good but are still a cost. Indirect labour, indirect materials, maintenance of the machines, depreciation and utility costs are all overhead costs. Some examples of indirect labour would be attributed to the cleaning of the factory, administrator wages and the salary of the accountant who does the costing. Some other examples of indirect costs are the wages paid to anybody who is not classed as direct labor, rentals or state taxes to run or own the manufacturing company and many more.
In the income statement direct materials, direct labor and manufacturing overhead costs are all highlighted on specific lines under the production costs. The cost of a single finished good is made up of the aforementioned three concepts. Ascertaining the measure of the components that have gone into making a single product helps a company properly analyze how much is required to arrive at their desired goal. Manufacturing companies must be well aware of how to identify these costs because wrongly classifying them can result in poor costing.
References
Edwards, D. J. & Hermanson, H. R. (N.D). Manufacturing Costs (Direct Materials, Labor, Manufacturing Overhead) and Product and Period Costs. https://courses.lumenlearning.com/sac-managacct/chapter/costs-and-expenses/
Fundamentals of Accounting. (2020). Direct Materials- Meaning and Examples. Cost Accounting . https://www.fundamentalsofaccounting.org/direct-materials/
