The cost of any product or service is the sum of various segments of the cost. Such segments are treated as elements of cost e.g. the cost of a chair prepared out of a piece of wood involves following cost elements:
Cost of raw materials (piece of wood)
Labor cost (wages paid to operator)
Overhead cost (Building and other services required for manufacturing chairs)
In general all types of manufacturing involve the following elements of cost:
1) Direct material cost, 2) Direct labor cost 3) Direct expenses, 4) Overhead cost; (i) Factory overheads, (ii) Administrative overheads, (iii) selling and distribution overheads.
Direct materials cost: Direct material cost in the cost of material (may be raw material unprocessed material fully or partly processed material, components etc) used for the manufacture of the units. It is directly traceable to the production units. The direct material cost includes the purchase price as well as incidental expenses such as freight, insurance, loading and unloading expenses, octroi, import duties etc. the expenses incurred or the primary packing materials are also treated a direct material cost. The expenses incurred for grease and oil, nails, etc leaning materials other consumable stores etc of common nature which are not traceable to any point of production. So, they are treated as direct material cost which forms a part of the overhead cost.
Direct labor cost: Direct labor cost consist of wages paid to the operators directly engaged in the manufacturing of the product. It also includes the wages paid to all such workers who are solely engaged in a particular type of production, job or contract which are directly attributable to that specific cost unit e.g. wages paid to the worker engaged in handling the product inside the department. Wages paid to the time keeper watchman sweeper etc are common nature expenses and are treated as indirect labor expenses. They are treated as indirect expenses and are treated as overhead costs.
Direct expenses are such expenses other than those incurred on direct material and direct labor which can be directly attributed to the cost unit. Such expenses are specially incurred on a particular job, contract or work order, e.g. cost of trial units, cost of special designs drawings molds of patterns cost of hiring special tools and equipment, consultancy for specific job etc.
It should be noted that direct cost, direct labor cost and direct expenses are collectively known s prime cost.
Overhead costs: are the indirect costs which cannot be directly attributed to any particular cost unit (i.e. a product, a job contract etc). They are also referred as overheads. Aforesaid materials direct labor and direct expenses are treated as direct cost and all expenses other than direct cost are treated as overheads or indirect expenses
Overheads are classified into the three groups: (1) Factory overheads (2) Administrative overheads, and (3) Selling and distribution overheads
Factory overhead: Factory overheads include all indirect expenses which are incurred in connection with the manufacture of a product. They are also known as works overheads, or factory burden or works burden. Factory overheads may be fixed or variable. Fixed factory overheads are those costs which do not vary with the volume of production e.g. rent on factory building salary of watchman, time keeper, supervisor, expenses on labor, welfare activities etc. Variable factory overheads vary directly with the volume of production. They include cost of fuel and power, cost of repair and maintenance cost of normal idle time of normal wastage and silage etc.
Administrative overheads include all those indirect expenses which are incurred in respect of general administration and management of an enterprise. These expenses are of common nature and are incurred for the business as a whole. They are apportioned among cost units on some appropriate basis. Like factory overheads, administrative overheads also tends be fixed and variable. The fixed administrative overheads include rent and rates on office buildings, salaries to clerical staff, salaries to executives, salaries to Managing director and directors’ legal charges audit fees etc. The variable expenses may include items like stationery postage, telephone charges, Lighting and heating expenses. They are more of a semi-variable mature.
Selling and distribution expenses are indirect costs which pertain to the marketing the product or services. They are not directly related to the cost of the products, jobs, contracts or services. Sometimes selling and distribution costs are separated with a view to apportion these overheads on some accurate basis. Like other overheads they also comprise on variable elements.