Elements of Cost
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In a manufacturing organization, where a product or a number of products are manufactured, the accounts department looks after the cost of production. Raw materials are converted into finished products with the help of labor, plant, etc. The cost of production is defined as the cost incurred to produce a product. The cost includes the cost of material, the cost of labor and the cost of factory, i.e. the rent of the factory premises, the cost of electricity and other things. Each of these elements is subdivided into direct and indirect elements. Direct material, Direct labor and Direct expenses can be traced back to the product being manufactured. But indirect material, Indirect labor and Indirect expenses cannot be traced to a single product. They can be allocated either to all the products or can be included in indirect cost.
Elements of cost can be defined as the elements that constitute the cost of production. They include (1) Material; (2) Labor; (3) Expenses.
1. Material:
Material includes two things (1) Direct Material and (2) Indirect Material. Direct material includes things like the raw material which goes into production. Ex: Leather bought by a shoe-making company. The leather is direct material.
But, other things like threads, glue, color or polish, etc cannot be called as direct material, but can be treated as indirect material.
2. Labor:
Cost of labor is the wages being paid to the laborers. These can be conveniently allocated to the element of labor. But, indirect wages are those wages paid to the labor that help the labor, but they directly don’t help in the production as such. These indirect laborers are helpers, cleaners, peons, etc. These indirect labor expenses cannot be allocated directly to the wages element but can be put under the head indirect labor charges.
3. Expenses:
Besides direct material and labor the manufacturing unit also needs to expend on things like cost of factory (rent), cost of power, etc. But, other expenses which are indirect in nature cannot be allocated to expenses element, instead, they are allocated to different heads called overhead expenses.
The overhead expenses include (1) Factory Overheads, (2) Administration Overheads, (3) Selling Overheads, (4) Distribution Overheads.
(1) Factory Overheads:
• Wages of all factory staff excluding those of direct workers
• Rent
• Taxes of factory
• Depreciation of factory assets
• Canteen expenses
• Labor welfare expenses
(2) Administration Overheads:
• Salary of administrative staff
• Rent
• Telegram and Telephone
• Stationery
• Lighting of administrative building
• Depreciation of office assets
(3) Selling Overheads:
• Salary of sales staff
• Travelers’ commission
• Advertisement
• Depreciation of Sales office assets
• Cost of participation in industrial fares and exhibitions
• Cost of free gifts and after-sales service
• Normal bad debts
(4) Distribution Overheads:
They refer to all the expenses incurred in connection with the delivery of a product after the sale is affected.
• Delivery expenses
• Freight and insurance
• Packing for delivery loading and unloading
• Salary of deliverymen
• Customs Duty
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