Product costs: A product cost is any cost that is associated with units of product for a particular

purpose. Hence, the identification of product costs depends on the purpose for which it is done.
For example, the factory manager is interested in manufacturing costs, whereas the
merchandising manager might be interested in both manufacturing and nonmanufacturing costs,
including research and development, marketing, and advertising costs.

Overview of Product Costing:

Product costing follows these steps:

1. Identify the cost object;

2. Identify the direct costs associated with the cost object;
3. Identify the overhead costs;
4. Select the cost allocation base to use in assigning overhead costs to the cost object;
5. Develop the overhead rate for allocating overhead to the cost object.

The cost accounting system “builds up” the cost of product (or other cost object) by recording to
a job cost sheet, a work-in-process account, or some other appropriate ledger, the direct costs that
can be traced to the product, and a share of the overhead costs, which are allocated to the
product by multiplying the overhead rate by the amount of the allocation base identified with the
cost object.

Cost Objects:
Recall that a cost object is anything that we want to know the cost of, such as a product or
service.

There is a common convention that can be confusing. We often talk about the cost object (the
thing we want to know the cost of) as one unit of product, because factory managers and product
managers speak in terms of unit costs. These managers want to know the unit cost for product
pricing, product sourcing, and performance evaluation purposes. They do not want to talk about
the cost of making 620 units, even if that is the batch size. However, in most batch processes,
there would be very little benefit and enormous additional expense in determining the cost of
each unit of product individually. Rather, the accounting system treats the batch as the cost
object, and to derive a unit cost, we divide the cost of the batch by the number of units in the
batch. Hence, loosely speaking, we talk as if a unit of product is the cost object, but more
precisely, it is the batch (or the production run in an assembly-line process, or perhaps one day’s
production in a continuous manufacturing process) that constitutes the cost object.

Direct Costs:
Management accounting classifies product costs as either direct costs or overhead costs (indirect
costs). This distinction is important because costing systems handle these two types of costs very
differently. The distinction is sometimes subtle, because whether a cost is direct or overhead is a
function of the cost object, and also partly a matter of choice on the part of managers and
accountants.

Following are three definitions of direct costs from different accounting textbooks:

Direct costs of a cost object are costs that are related to the cost object and can be traced
to it in an economically feasible way.

Direct costs are costs that can be directly attached to the unit under consideration.

Direct costs are costs that can be traced easily to specific products.

Direct costs are also called prime costs. For manufacturing companies, direct costs usually can
be categorized as either materials or labor.

Direct materials: materials that become part of the finished product and that can be
conveniently and economically traced to specific units (or batches) or product.

Example of direct materials for an apparel manufacturer: fabric. All other materials, such as
thread and zippers, are probably indirect.

Direct labor: costs for labor that can be conveniently and economically traced to a unit (or
batch) of product. The following examples show how the determination of whether a cost is
direct or overhead depends on the identification of the cost object:
Examples of direct labor for an apparel manufacturer:

1) If the cost object is a single pair of pants, in a batch of several dozen pairs:

Probably no labor is direct.

2) If the cost object is a batch of several dozen pairs of pants:

Probably, sewing operators’ wages are direct.

3) If the cost object is a production line in the factory, add:

The line manager’s salary, and possibly wages incurred in the cutting room (where rolls
of fabric are cut into panels and pieces that are then sewn together).

4) If the cost object is the entire factory, add:

The factory manager’s salary, wages of maintenance and janitorial workers, and salaries
of front office personnel.

Even though probably no labor is direct with respect to a single pair of pants, if labor is direct
with respect to a batch of 50 or 100 units, cost accountants would usually (and loosely) call labor
a direct cost with respect to units of product, and divide the direct labor cost for the batch by the
number of units per batch to derive the direct labor cost per unit.

Overhead Costs:
Overhead costs are costs that are related to the cost object, but cannot be traced to the cost object
in an economically feasible way. Overhead costs are not directly traceable to specific units of
production. Examples of overhead costs incurred at an apparel manufacturer, when the cost
object is a batch of product, probably include the following:

- Electricity
- Factory office salaries
- Building and machine maintenance
- Factory depreciation

The distinction between direct costs and overhead costs relate, in some measure, to the way the
accounting system treats the cost. For example, one apparel manufacturer might track thread
using the same methods that are used to track fabric, thus treating thread as a direct material.
Another apparel manufacturer might decide that the cost of thread is immaterial, and does not
warrant the cost and effort to track it as a direct cost. For this company, thread is an overhead
cost. Therefore, whether some costs are direct or overhead depend on a choice made by the
manager and the cost accountant.
There are three ways overhead costs can be treated in any decision-making context: (1) they can
be ignored, (2) they can be treated as a lump-sum, or (3) they can be allocated to the products
and services (i.e., to the cost objects) to which they relate. Each of these three alternatives is
appropriate, depending on the circumstances and the purpose for which the accounting is done.
However, in this chapter and throughout much of this book, we are concerned with the third
alternative: how to allocate overhead costs to products and services.

Cost Allocation Bases

The allocation base is the “link” that is used to attach overhead costs to the cost object. In a
manufacturing setting, the simplest allocation base is the number of units produced. For example,
if the factory makes 15,000 units, the accounting system can simply “spread” the overhead costs
evenly over all 15,000 units. The problem with using units as an allocation base, however, is that
if the factory makes a range of different products, those products might differ significantly in
their resource utilization. A deluxe widget might require twice as much labor and 20% more
materials than a standard widget, and one might infer that the deluxe widget also requires more
resources that are represented by overhead costs.

Whatever cost allocation base is chosen, it must be a “common denominator” across all cost
objects. For example, a furniture factory could allocate overhead costs across all products using
direct labor hours, because direct labor is incurred by all products made at the factory. However,
it would not seem appropriate to allocate factory overhead based on the quantity of wood used in
each unit, if the factory makes both wood furniture and a line of plastic-molded, because no
overhead would be allocated to the plastic chairs.

Overhead Rates:
The overhead rate is the ratio of cost pool overhead dollars in the numerator, and the total
quantity of the allocation base in the denominator:

Overhead rate = Overhead costs in the cost pool

Total quantity of the allocation
base
The result represents dollars of overhead per unit of the allocation base. For example, if an
apparel factory allocates overhead based on direct labor hours, the overhead rate represents
dollars of overhead per direct labor hour. Assume the overhead rate is $20 per direct labor hour.
Then for every hour that a sewing operator spends working on product, $20 will be allocated to
the products that the sewing operator assembles during that hour.
ZFN Apparel Company, Example of Actual Costing:
The ZFN apparel company in Albuquerque, New Mexico makes jeans and premium chinos.
Each product line has its own assembly line on the factory floor. Overhead costs for the factory
for 2005 were $3,300,000. 500,000 jeans and 400,000 chinos were produced during the year.
500,000 direct labor hours were used: 200,000 for jeans, and 300,000 for chinos. The average
direct labor wage rate was the same on both assembly lines, and was $14 per hour. Denim fabric
is used to make jeans, and chinos are made from a cotton twill fabric. Overhead is allocated
using direct labor hours.

The following journal entries and T-accounts illustrate how the accounting system records the
manufacturing activities of the factory in order to derive product cost information for jeans and
chinos. Journal entry (6) to debit overhead to work-in-process is based on an overhead rate
calculated as follows.

$3,300,000 ÷ 500,000 direct labor hours = $6.60 per direct labor hour.

In practice, the factory would track costs by batch, or perhaps weekly, but to simplify our
example, we record only one journal entry for each type of transaction. We also make the
unrealistic assumption that there is no work-in-process at the end of the period. To focus the
presentation on inventory-related accounts, T-accounts for some non-inventory accounts, and the
entry to debit accounts receivable and credit revenue, are omitted.
(1) Raw Materials: denim fabric $3,000,000
Raw Materials: cotton twill 2,250,000
Accounts Payable $5,250,000

(To record the purchase of 600,000 yards of denim fabric at $5.00 per
yard, and 500,000 yards of cotton twill fabric at $4.50 per yard.)

(2) Work-in-process: Jeans $2,500,000

Raw Materials: denim fabric $2,500,000

(To record materials requisitions for 500,000 yards, for the movement of
denim from the receiving department to the cutting room.)

(3) Work-in-process: Chinos $2,160,000

Raw Materials: cotton twill $2,160,000

(To record materials requisitions for 480,000 yards, for the movement of
cotton twill from the receiving department to the cutting room.)

(4) Work-in-process: Jeans $2,800,000

Work-in-process: Chinos 4,200,000
Accrued Sewing Operator Wages $7,000,000

(To record sewing operator wages for the year: 200,000 hours for jeans,
and 300,000 hours for chinos, at $14 per hour.)

(5) Factory Overhead $3,300,000

Accounts Payable $1,800,000
Accrued Wages for Indirect Labor 900,000
Accumulated Depreciation 600,000

(To record overhead costs incurred during the year, including utilities,
depreciation, repairs and maintenance, and indirect wages and salaries.)

(6) Work-in-process: Jeans $1,320,000

Work-in-process: Chinos 1,980,000
Factory Overhead $3,300,000

(To allocate factory overhead to production, using an overhead rate of

$6.60 per direct labor hour.)
(7) Finished Goods: Jeans $6,620,000
Work-in-process: Jeans $6,620,000

(To record the completion of all 500,000 jeans, at $13.24 per pair.)

(8) Finished Goods: Chinos $8,340,000

Work-in-process: Chinos $8,340,000

(To record the completion of all 400,000 chinos, at $20.85 per pair.)
(9) Cost of Goods Sold: Jeans $5,296,000
Cost of Goods Sold: Chinos $7,297,500
Finished Goods: Jeans $5,296,000
Finished Goods: Chinos $7,297,500

(To record the sale of 400,000 jeans and 350,000 chinos.)

Raw Materials: Raw Materials:

Denim Fabric Cotton Twill
(1) $3,000,000 $2,500,000 (2) (1) $2,250,000 $2,160,000

$ 500,000 $ 90,000

Accrued Sewing
Operator Wages Factory Overhead
$7,000,000 (4) (5) $3,300,000 $3,300,000

$0

Work-in-Process: Jeans Work-in-Process: Chinos

(2) $2,500,000 $6,620,000 (7) (3) $2,160,000 $8,340,000

(4) 2,800,000 (4) 4,200,000
(6) 1,320,000 (6) 1,980,000
$0 $0

Finished Goods: Jeans Finished Goods: Chinos

(7) $6,620,000 $5,296,000 (9) (8) $8,340,000 $7,297,500

$1,324,000 $1,042,500

Cost of Goods Sold: Jeans Cost of Goods Sold: Chinos

(9) $5,296,000 (9) $7,297,500

 Accounts Payable

$5,250,000 (1)
1,800,000 (5)

The per-unit inventory cost is calculated as follows:

Jeans: $6,620,000 ÷ 500,000 pairs = $13.24 per pair

Chinos: $8,340,000 ÷ 400,000 pairs = $20.85 per pair

These amounts, which are used in journal entry (9), can be detailed as follows:

Input Jeans Chinos

Fabric 1 yard per jean x $5 per yard = 1.2 yards per chino x $4.50 per yard =
Direct $5.00 $5.40
labor 0.4 hours per jean x $14 per hour 0.75 hours per chino x $14 per hour =
Overhead = $5.60 $10.50
Total 0.4 hours per jean x $6.60 per hour 0.75 hours per chino x $6.60 per hour =
= $2.64 $4.95
$13.24 $20.85

In the above table, the direct labor hours per jean and per chino appear in the lines for both the
per-unit direct labor cost and the per-unit overhead cost, because overhead is allocated based on
direct labor hours. If the allocation base had been something else, such as machine hours, the
hours per unit would only appear in the calculation of the direct labor cost.

More overhead is allocated to each pair of chinos than to each pair of pants ($4.95 versus $2.64)
because direct labor hours has been chosen as the allocation base, and each chino requires more
direct labor time than each pair of jeans (0.75 hours versus 0.40 hours). Changing the allocation
base cannot change the total amount of overhead incurred, but it will usually shift costs from
some products to others. For example, if the allocation base were units of production instead of
direct labor hours, the overhead rate would be:

$3,300,000 ÷ 900,000 units = $3.67 per unit.

In this case, the total cost per pair of jeans would increase from $13.24 to $14.27, and the total
cost per pair of chinos would decrease from $20.85 to $19.57.

Because the choice of allocation base determines how overhead is allocated across products,
product managers usually have preferences over this choice (because a lower reported product
cost results in higher reported product profitability). However, the company’s choice of
allocation base should be guided, if possible, by the cause-and-effect relationship between
activity on the factory floor and the incurrence of overhead resources. For example, direct labor
hours is a sensible allocation base if the significant components of overhead increase as direct
labor hours increase. More direct labor implies more indirect labor by human resources and
accounting personnel, janitorial staff and other support staff. Also, more direct labor implies
more machine time, which implies more electricity usage, and more repairs and maintenance
expense. For these reasons, direct labor hours is probably a better choice of allocation base than
units of product.

The textile industry generally concentrates on designing or manufacturing of clothes and also the task of
distribution and use of the manufactured textile.

The textile industry has changed continuously in the last few years. It looks at carrying out their business
in systematic way. For this reason ERP can be used and it plays an important role. As we know ERP
stands for enterprise resource planning. Therefore the major goal is plan out the resources used and
keeping a proper data in software.

It is software for a business; which can be customized according to the needs of the enterprise. The ERP
software is the latest high end solution for performing the business efficiently. The software aims at
keeping a track of data and making internal procedure flow smoothly.

ERP has helped in increasing the quality and efficiency of

the manufacturing process. The manufacturing processes
experiences some problems quiet often because of
miscommunication and lack of communication. ERP
provides a solution by enhancing coordination by keeping
an eye on the supply chain, warehouse and logistic.

It also helps greatly in the function of tracking the

progress made in the manufacturing of the product. If any
technical problem occurs it can be tracked down easily.
The customer can be answered easily with the statistics
in hand and his queries can be easily answered with the
details of the status of the product. Long chains of
communication are shortened and the details can be
shared through internet also, thus avoiding any
miscommunication.

For both textile and garment sector strategic planning is important and ERP system is designed to
support this through resource planning. It facilitates report generation which has to be updated every time
a progress takes place. This report can be distributed among employees so that they also know which
area has to be given more attention for the completion of the task. The textile and garment industry is
ever-changing and thus it is important to know the customers need and record it.

It helps reduce operating cost because it integrates processes of the business across departments onto a
single information system. The problem of low inventory or reduced operating cost is ruled out. Whenever
resource is needed it is available on time because everything has already been planned. The day to day
management becomes easy because it keeps a track of the warehouse also. Everything going into the
data warehouse is recorded thus planning for a specific day can be easily done. Due to the fact that every
activity is recorded the actual cost can be calculated easily. The unwanted ambiguity is ruled out which
makes the database user friendly.

Since the product is being managed so well its quality remains intact what the world gets is a reliable
product. Every small detail can be easily taken care of and smooth flow of activity takes place.

About the Author:

He writes on alternative health and has contributed lot of articles on natural cures, ayurveda, massage,
yoga and home remedies. He is founder and CEO of Elite Informatics, an Internet Advertising Company

The textile industry generally concentrates on designing or manufacturing of clothes

and also the task of distribution and use of the manufactured textile.

The textile industry has changed continuously in the last few years. It looks at
carrying out their business in systematic way. For this reason ERP can be used and
it plays an important role. As we know ERP stands for enterprise resource planning.
Therefore the major goal is plan out the resources used and keeping a proper data
in software.

It is software for a business; which can be customized according to the needs of the
enterprise. The ERP software is the latest high end solution for performing the
business efficiently. The software aims at keeping a track of data and making
internal procedure flow smoothly.

ERP has helped in increasing the quality and efficiency of the manufacturing
process. The manufacturing processes experiences some problems quiet often
because of miscommunication and lack of communication. ERP provides a solution
by enhancing coordination by keeping an eye on the supply chain, warehouse and
logistic.

It also helps greatly in the function of tracking the progress made in the
manufacturing of the product. If any technical problem occurs it can be tracked
down easily. The customer can be answered easily with the statistics in hand and
his queries can be easily answered with the details of the status of the product.
Long chains of communication are shortened and the details can be shared through
internet also, thus avoiding any miscommunication.

For both textile and garment sector strategic planning is important and ERP system
is designed to support this through resource planning. It facilitates report
generation which has to be updated every time a progress takes place. This report
can be distributed among employees so that they also know which area has to be
given more attention for the completion of the task. The textile and garment
industry is ever-changing and thus it is important to know the customers need and
record it.

It helps reduce operating cost because it integrates processes of the business

across departments onto a single information system. The problem of low inventory
or reduced operating cost is ruled out. Whenever resource is needed it is available
on time because everything has already been planned. The day to day management
becomes easy because it keeps a track of the warehouse also. Everything going
into the data warehouse is recorded thus planning for a specific day can be easily
done. Due to the fact that every activity is recorded the actual cost can be
calculated easily. The unwanted ambiguity is ruled out which makes the database
user friendly.

Since the product is being managed so well its quality remains intact what the
world gets is a reliable product. Every small detail can be easily taken care of and
smooth flow of activity takes place.

Why ERP Works

Enterprise resource planning or ERP is the way to go for optimal usage of resources. Here’s what
ERP is all about…Text by Manish Dalal

While selecting an Enterprise Resource Plan (ERP) for the apparel sector, one must consider an
essential factor should you go for a General Purpose ERP that will be customised for the apparel
sector, or should you go for an Apparel pecific ERP? Both have a far-reaching impact on the
implementation and effectiveness of the ERP on the organisation.

Being able to respond quickly to the sales pattern at our various EBOs is a great advantage of
implementing the ERP - Bobby Arora,

One distinct feature that distinguishes an Apparel Specified ERP from a General Purpose ERP is
that in apparel, the users need to deal with various sizes for the same product style and colour
combination. This means that in the apparel sector users are accustomed to viewing reports, as
well as input data with sizes appearing across the page rather than one below the other as would
happen when a General Purpose ERP is implemented. To illustrate, the order booking form in an
Apparel Specific ERP would look something like this:
On the other hand, the order form in a General Purpose ERP, unless it has been specifically
configured to be in the format above, looks like the following:

The basic advantage in having a horizontal structure as in the General Purpose ERP is that you
can have various sizes till any number and of any description, and all can be easily fitted into the
ERP. But in the Garment specific ERPs, the number and types of sizes may be restricted in
number, if not in type. Normally, up to 3 sizes can be accommodated in the Header column
without causing any confusion. However, if the types of size numbers increase, then specific
sizes need to be indicated against each style.

With the ERP in place, we are able to quickly know of the events occuring in our company
without any additional effort
- Kamal Limbad, Director Roop Designs Pvt. Ltd.

For an apparel brand which also has manufacturing as a part of its core activities, either through
in-house facilities or through supporting job workers, a typical ERP should have all the basic
functions that the company has to deal with in respect to planning for the season, procurement of
fabric and trims, issuing for cutting and stitching and then tracking its movement till it is
received in the finished warehouse. Then onwards, the orders received from customers need to
be tracked for deliveries and realisation of monies, issue of credit notes for sales return etc. A
typical Apparel ERP can be diagrammatically represented as follows:

Flow Chart for the ERP Software at the head office

Management

As seen in the diagram, an Apparel ERP can be broadly divided into 4 modules:
• Planning
• Procurement and production
• Sales and distribution
• Accounts

The diagram distinctly reveals the various broad functions of the manufacturer i.e. the Planning
Module wherein the styles that are to be launched are defined. Then the Sales and Distribution
Module comes into play wherein the orders received are matched with available stocks and then
the goods are dispatched and invoiced. Finally, there is the Accounts Module wherein the
financial entries get recorded.

The dark lines joining Product Definition with Garment Purchase, Orders Received, EBO Orders
and Cutting Issue indicate that these activities can be started independent of each other as soon as
the Product is defined.

In our next issue we shall take an in-depth look into how each of these modules works. The
implementation of an ERP in the apparel sector has its own peculiar features and dynamics that
need to be taken into account while selecting an ERP. A well designed ERP is one that reflects
the actual occurrence of events in the physical form on to the computers. So watch out for further
details on the process of formulating and executing an effective ERP in the apparel industry.

definition -

ERP (enterprise resource planning) is an industry term for the broad set of activities that helps a
business manage the important parts of its business. The information made available through an
ERP system provides visibility for key performance indicators (KPIs) required for meeting
corporate objectives. ERP software applications can be used to manage product planning, parts
purchasing, inventories, interacting with suppliers, providing customer service, and tracking
orders. ERP can also include application modules for the finance and human resources aspects of
a business. Typically, an ERP system uses or is integrated with a relational database system.

Leveraging Your ERP System for Continuous

Business Improvement
by Dave Litzenberg | View all posts by Dave Litzenberg

So, you’re an owner of a small to mid-market manufacturing or distribution company. Your

business is making a nice profit and you’re pleased with your personal earnings from the
venture. Even so, it’s not time to rest on your laurels and be satisfied with the status quo.

Every day, there’s someone out there who wants to eat your lunch. It could be an existing
competitor who wants to get the upper hand, or it could be someone with a new idea to turn your
industry upside down. Whatever the source of the threat, it is real, and it is coming.

Thus, it is imperative to make on-going adjustments in your business for purposes of continuous
improvement unless you want to wake up some day to be the person wondering, “What hit me?”’

There are so many manufacturing and distribution businesses we walk into where “that’s just the
way we do things around here” is a widely-used term. For example:

• We always buy substantially more product than we need at the time because we get an
additional discount from our supplier.
• We always have three people sequentially check the same order and its pricing before it
is billed so our customers always receive a clean invoice.
• We couldn’t possibly require the receiving people to record lot numbers because it will
hurt their productivity.
• We allow our customer to buy a full container of product and pay us for it over a twelve
month period, even though the customer sells all of the associated product in six months
and is using us as their bank for interest-free money for the last six months.
• We aren’t interested in going out and finding any new customers; we have more than
enough business from the two big customers we’re already working with.

These are but five of the countless statements we’ve heard over the past several years about why
businesses do quirky things – just because, “that’s the way it’s done here.”

Every day in business is a new opportunity to change old ways and to make improvements that
can lead to improved operational efficiencies and customer service. No one can afford waste in
their businesses. Customers are unwilling to pay a premium for your products to absorb your
excess costs because you’re doing things the way they’ve always been done.

You’re encouraged to challenge the norm by setting up continuous improvement teams and
rewarding your personnel to cut waste and streamline business processes. And, assuming you
have a high-quality manufacturing or distribution software system in place like Enterprise 21 in
which data and metrics are available for ease of access and analysis through fully-integrated
decision support and workbench technologies and are working with a software vendor like
Technology Group International who is seen as a strategic partner to many customers bringing
best-practice experience from working with a myriad of small to mid-market manufacturing and
distribution customers, your ERP system can be a key enabler for your company’s continuous
improvement efforts.

Technology Group International is such a strong believer in continuous improvement that we

perform return on investment (ROI) workshops with our customers some six to twelve months
after their initial Go Live with TGI’s Enterprise 21 ERP software. During an ROI workshop, the
customer reviews key business practices from across their enterprise and how they’re using
Enterprise 21 in those situations. While there are numerous recommendations as to how the
manufacturer or distributor can take better advantage of the software they’ve already bought,
some 3-5 key elements tend to emerge for improvement out of the workshop that can help the
given manufacturer or distributor derive substantial incremental ROI with the software they’ve
already installed.