Elements of Costs

Elements of Cost

Following are the three broad elements of cost:

1. Material

The substance from which a product is made is known as material. It may be in a raw or a manufactured state. It can be direct as well as indirect.

a. Direct Material

The material which becomes an integral part of a finished product and which can be conveniently assigned to specific physical unit is termed as direct material. Following are some of the examples of direct material:

 All material or components specifically purchased, produced or requisitioned from stores

 Primary packing material (e.g., carton, wrapping, cardboard, boxes etc.)

 Purchased or partly produced components

Direct material is also described as process material, prime cost material, production material, stores material, constructional material etc.

b. Indirect Material

The material which is used for purposes ancillary to the business and which cannot be conveniently assigned to specific physical units is termed as indirect material. Consumable stores, oil and waste, printing and stationery material etc. are some of the examples of indirect material.

Indirect material may be used in the factory, office or the selling and distribution divisions.

2. Labor

For conversion of materials into finished goods, human effort is needed and such human effort is called labor. Labor can be direct as well as indirect.

a. Direct Labor

The labor which actively and directly takes part in the production of a particular commodity is called direct labor. Direct labor costs are, therefore, specifically and conveniently traceable to specific products.

Direct labor can also be described as process labor, productive labor, operating labor, etc.

b. Indirect Labor

The labor employed for the purpose of carrying out tasks incidental to goods produced or services provided, is indirect labor. Such labor does not alter the construction, composition or condition of the product. It cannot be practically traced to specific units of output. Wages of storekeepers, foremen, timekeepers, directors’ fees, salaries of salesmen etc, are examples of indirect labor costs.

Indirect labor may relate to the factory, the office or the selling and distribution divisions.

3. Expenses

Expenses may be direct or indirect.

a. Direct Expenses

These are the expenses that can be directly, conveniently and wholly allocated to specific cost centers or cost units. Examples of such expenses are as follows:

 Hire of some special machinery required for a particular contract

 Cost of defective work incurred in connection with a particular job or contract etc.

Direct expenses are sometimes also described as chargeable expenses.

b. Indirect Expenses

These are the expenses that cannot be directly, conveniently and wholly allocated to cost centers or cost units. Examples of such expenses are rent, lighting, insurance charges etc.

4. Overhead

The term overhead includes indirect material, indirect labor and indirect expenses. Thus, all indirect costs are overheads.

A manufacturing organization can broadly be divided into the following three divisions:

o Factory or works, where production is done

o Office and administration, where routine as well as policy matters are decided

o Selling and distribution, where products are sold and finally dispatched to customers

Overheads may be incurred in a factory or office or selling and distribution divisions. Thus, overheads may be of three types:

d. Factory Overheads

They include the following things:

 Indirect material used in a factory such as lubricants, oil, consumable stores etc.

 Indirect labor such as gatekeeper, timekeeper, works manager’s salary etc.

 Indirect expenses such as factory rent, factory insurance, factory lighting etc.

e. Office and Administration Overheads

They include the following things:

 Indirect materials used in an office such as printing and stationery material, brooms and dusters etc.

 Indirect labor such as salaries payable to office manager, office accountant, clerks, etc.

 Indirect expenses such as rent, insurance, lighting of the office

f. Selling and Distribution Overheads

They include the following things:

 Indirect materials used such as packing material, printing and stationery material etc.

 Indirect labor such as salaries of salesmen and sales manager etc.

 Indirect expenses such as rent, insurance, advertising expenses etc.

Elements of Cost

o Direct material

o Direct labor

o Direct expenses

o Overheads

o Factory overheads

o Selling and distribution overheads

o Office and administration overheads

o Indirect material

o Indirect labor

o Indirect expenses

o Indirect material

o Indirect labor

o Indirect expenses

o Indirect material

o Indirect labor

o Indirect expenses