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

*rom the table we can observe that direct materials are the integral part and a significant portion of finished goods.

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2. Direct La or
(irect wages (labour costs) are the wages which can be identified with and allocated to cost centres and cost units. (irect labour is the labour e+pended in altering the condition, conformation or composition of the product. -lmost any production plant or factory requires employees to operate equipment, move raw materials from the warehouse to equipment, and so on. These employees are directly involved in the production process and cost of their remuneration and benefits represents direct labor. (irect labor is the cost of wages to be paid to individuals who wor& on specific products or in other words, the cost of wages of employees who are directly involved in converting raw materials into finished goods. .sually direct labor is a variable cost. In most situations the amount of direct labor required is directly correlated with the amount of finished goods produced. *or e+ample, wages and related benefits of employees who operate machinery to produce valves represent direct labor costs for a company. The more valves are to be produced, the more employees will be required to operate machinery, paint, assemble, etc. (irect materials and direct labor, when added together, represent the prime cost. (irect materials and direct labor are called prime costs because they are directly (physically, /primarily/) associated with the production of the finished good.

!. "actor# O$er%ead
*actory (or production) overhead is any manufacturing cost that is not direct materials or direct labor. *actory overhead includes all indirect material cost, indirect wages, and indirect e+penses incurred in the factory from the receipt of the order until its completion ready for dispatch.

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Indirect materials Indirect wages Indirect e+penses

*actory overhead can have variable or fi+ed nature, depending on whether overhead changes in direct proportion with production levels. 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

,roperty ta+es ,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, 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. *or e+ample, a manufacturing company may treat the following costs as indirect materials: oil lubricants and light bulbs used in manufacturing equipment, pac&age bo+es, wrenches, etc. Other companies will have different types of indirect materials depending on their manufacturing processes. The table below provides a few e+amples.

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Illustration ': Examples of indirect materials cost (o$er%ead cost) Examples ,ublishing company -utomobile manufacturer !omputer manufacturer Indirect Materials 4lue, printing press lubricants, etc *actory light bulbs, drill bits etc. -ssembly line lubricants, screwdrivers, polishers, etc.

-s can be seen from the table, indirect materials are an insignificant portion or not an integral part of the finished goods. Indirect la or is the cost of production employees who are involved in the manufacturing process, but do not wor& on a specific product. *or e+ample, wages of custodians, maintenance people, supplies room supervisors, etc. are considered indirect labor. (irect labor and factory overhead, when added together, represent the con$ersion cost. (irect labor and factory overhead are called conversion costs because they are involved in converting raw materials into finished goods. Illustration below shows relationship between direct materials, direct labor, overhead, prime cost and conversion cost.

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Illustration *: +elations%ip et,een direct materials- direct la or- o$er%ead- prime cost and con$ersion cost

.dministration o$er%ead: -dministration overhead includes all indirect materials cost, indirect wages and indirect e+penses incurred in the direction, control and administration of an underta&ing. Sellin/ o$er%ead: 3elling overhead includes all indirect materials cost, 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, 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.

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Non0manufacturin/ Costs
!ost accountants are now bestowing attention to non manufacturing costs as well. There is a reali%ation that these costs need to be analy%ed more penetratingly for purposes of planning and control. 5on manufacturing costs categori%ed into four components: (i) (ii) (iii) (iv) (istribution costs, 6esearch and development costs, *inancial costs, and -dministrative costs.

a) Distri ution Costs These include costs incurred in mar&eting related activities such as selling, distribution, transportation advertising, sales promotion, etc. ) +esearc% and De$elopmental Costs These are incurred for developing new products or processes, improving e+isting products or processes, and searching for new &nowledge. 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. c) "inancial Costs The principal financial cost is the interest on wor&ing capital advance, term loans, and debentures. Other financial costs that may be incurred by a business are commitment fee and ban& commission.

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

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+E"E+ENCES
!olin (rury (899:). $anagement and !ost -ccounting, ;th edition. 5ew <or&: =oo&power 0dmonds, Olds, and $c5air (899>). *undamental *inancial and $anagerial -ccounting !oncepts. =oston: $c4raw "ill "orngren, !. T. et al (899?). !ost -ccounting: - $anagerial 0mphasis, @A th edition. 5ew (elhi: ,rentice "all 2al Bawahar (899C). $anagerial -ccounting. (elhi: "imalaya ,ublishing "ouse 1eetman ,auline (899;). *inancial and $anagement -ccounting, :th edition. 2ondon: ,rentice "all http:''simplestudies.com'manufacturing nonmanufacturing costs.html http:''professionalpractice.asme.org'1riting'!ost'0lementsD!ost.cfm http:''www.futureaccountant.com'process costing'study notes'cost elements components recording accounting methodology.php

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