Manufacturing costs are the costs incurred to produce a product. Remember that a product refers to both goods and services.
The elements of manufacturing costs are :
- Material costs,
- Labour costs; and
- Overhead costs.
These elements make up the total cost of a product, as shown below:
Total product cost = Material cost + Labour Cost + overhead cost
These costs are discussed further in the following sections.
- Material costs;
Material refers to all the physical inputs into the production process. They include the following:
- Raw material refers to bought in material which is used in the manufacture of the product. According to the organization raw material may further be classified as steel, timber e.t.c.
- Components and subassemblies i.e. bought in components and subassemblies which are incorporated in the product
- Work in progress i.e. partly completed assemblies and products incorporating raw materials and or subassemblies
- Consumable materials i.e. materials used in the operation of the factory and during production but do not appear in the product e.g. detergents
- Maintenance materials i.e. materials of all types used in maintaining machinery, buildings and vehicles e.g. spare parts, lubricating oil and grease
- Office materials; materials used in operation of the office e.g. stationery
- Labour costs
What is labour?
Labour costs could be direct or indirect labour costs.
Direct labour cost refers to wages paid to workers who are directly involved in the conversion of raw materials into finished goods. These are called direct labour costs
Indirect labour costsrefers to the wages paid to workers whose efforts cannot be readily identified with specific product units or batches e.g. labourers paid to maintain all the premises utilized for production of goods and services.
- Overhead costs:
They are also called indirect production costs. They are those costs which can only be charged to a cost unit using some estimated basis. The estimating procedure allows a share of the indirect costs to be charged to each cost unit. These costs cannot be identified specifically to the end product.
Importance of cost classification
Analysis of cost behaviour is important to all organizations for effective management. This is because many organizations have a unique cost structure. For example, fixed costs account for 60 – 80% of all hospital costs. However, unlike many organizations of this type, labour costs largely comprise the hospital’s fixed costs.
Labour costs unlike depreciation require a cash outflow. This is characteristic of labour intensive organizations. Capital-intensive organizations, on the other hand, have low labour costs, e.g. computerized manufacturing organizations.
Some organizations e.g. hospitals allocate 10 –15% of their space for standby emergency events giving them built in idle capacity. This prevents them from enjoying advantages of higher profits that a capital-intensive organization realizes at higher volumes beyond the break-even volume. Thus the cost structure of healthcare institutions presents challenges to accountants because of their labour intensive and capital-intensive characteristics.