Manufacturing Cost Elements 1

Cost Concepts Cost refers the amount of expenses spent to generate product or services. Cost refers expenditure that may be actual or nominal expenses incurred to generate output. Cost is the value of economic resources used as result of producing or doing the things. Cost has many meaning but in management cost refers the expenditure not the price. As a manager we use cost information for taking decisions and making plans, programs and policies and strategies. 2

Manufacturing Costs Defined Manufacturing costs are those costs that are directly involved in manufacturing of products and services. Examples of manufacturing costs include raw materials costs and salary of labor workers. Manufacturing cost is divided into three broad categories by most companies. 3

Cont… Sum of all the expenditures for the inputs of the system (i.e. purchased components, energy, raw materials, etc.) and for disposal of the wastes produced by the system 4

Direct Materials Cost: The materials that go into final product are called raw materials. This term is somewhat misleading, since it seems to imply unprocessed natural resources like wood pulp or iron ore. Actually raw materials refer to any materials that are used in the final product; and the finished product of one company can become raw material of another company. For example plastic produced by manufacturers of plastic is a finished product for them but is a raw material for Compaq Computers for its personal computers. 5

Direct Labor Cost The term direct labor is reserved for those labor costs that can be essentially traced to individual units of products. Direct labor is sometime called touch labor, since direct labor workers typically touch the product while it is being made. The labor cost of assembly line workers, for example, is a direct labor cost, as would the labor cost of carpenter, bricklayer and machine operator. 6

Cont… Prime Cost = Direct Materials Cost + Direct Labor Cost Manufacturing Overhead Cost: Manufacturing overhead, the third element of manufacturing cost, includes all costs of manufacturing Except direct material and direct labor. Examples of manufacturing overhead include items such as indirect material, indirect labor, maintenance and repairs on production equipment and heat and light, property taxes, depreciation, and insurance on manufacturing facilities. 7

Non-manufacturing Costs: Non-manufacturing costs are those costs that are not incurred to manufacture a product. Examples of such costs are salary of sales person and advertising expenses. Generally non-manufacturing costs are further classified into two categories. 1. Marketing and Selling Costs 2. Administrative Costs 8

Cont… Marketing or Selling Costs: Marketing or selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customers. These costs are often called order getting or order filling costs. Examples of marketing or selling costs include advertising costs, shipping costs, sales commission and sales salary. 9

Cont… Administrative Costs: Administrative costs include all executive, organizational, and clerical costs associated with general management of an organization rather than with manufacturing, marketing, or selling. Examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration of the organization as a whole. 10

Estimate the Manufacturing Costs 11

Cont… 12

Elements of the Manufacturing Cost of a Product 13

Cont… Component Costs (parts of the product) Parts purchased from supplier Custom parts made in the manufacturer’s own plant or by suppliers according to the manufacturer’s design specifications Assembly Costs (labor, equipment, & tooling) Overhead Costs (all other costs) Support Costs (material handling, quality assurance, purchasing, shipping, receiving, facilities, etc.) Indirect Allocations (not directly linked to a particular product but must be paid for to be in business) 14

MANUFACTURING COSTS 1. Direct Materials (DM) Materials that are consumed in the manufacturing process and physically incorporated in the finished product Materials whose cost is sufficiently large to justify the record keeping expenses necessary to trace the costs to individual products 15

Cont… 2. Direct Labor (DL) Labor time that is physically traceable to the products being manufactured Labor time whose cost is sufficiently large to justify the record keeping expenses necessary to trace the costs to individual products Example: Direct labor for manufacturing Honda Accords Line workers, robot operators, painters, assembly workers Any labor probably not included in direct labor? Factory janitors, factory supervisors, factory secretaries 16

Cont… 3. Manufacturing Overhead (OH) All of costs of manufacturing excluding direct materials and direct labor a. Indirect Materials (IM) – Materials, used in the manufacturing of products, which are difficult to trace to particular products in an economical way Glue, nails, cleaning supplies b. Indirect Labor (IL) – Labor, used in the manufacturing of products, which is difficult to trace to particular products in an economical way Wages for maintenance workers, factory supervisor’s salary, idle time 17

Cont… C. All other types of manufacturing overhead Depreciation on machinery, depreciation on factory building, factory insurance, utilities for factory 18

NON-MANUFACTURING COSTS 1. Marketing or Selling Costs – Costs incurred in securing orders from customers and providing customers with the finished product Sales commissions, costs of shipping products to customers, storage of finished goods, depreciation of selling equipment (cash register) 2. Administrative Costs – Executive, organizational, and clerical costs that are not related to manufacturing or marketing CEO’s salary, cost of controller’s office, depreciation on administrative building. 19

COST FLOWS IN A MANUFACTURING COMPANY  Inputs such as labor and capital equipment are also incurred to make the product. The costs of all the inputs used in the manufacturing facilities are recorded in WORK IN PROCESS INVENTORY As products are finished, they are moved to finished goods warehouse and their costs are recorded in FINISHED GOODS (FG) INVENTORY 20

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Product Costs Product costs (also called inventoriable costs) include each of the manufacturing cost elements (direct materials, direct labor, and manufacturing overhead). They are the costs that are a necessary and integral part of producing the finished product. These costs are not expensed (as cost of goods sold) under the matching principle until the finished goods inventory is sold. 22

Product Costs: Prime and Conversion Direct materials and direct labor are often referred to as prime costs due to their direct association with the manufacturing of the finished product. Direct labor and manufacturing overhead are often referred to as conversion costs since they are incurred in converting raw materials into finished goods. 23

Period Costs Period costs are identifiable with a specific time period rather than a salable product. Period costs are deducted from revenues in the period in which they are incurred. Period costs relate to nonmanufacturing, (thus, noninventoriable) costs, and include selling and administrative expenses. 24

Costs Related to Decision Making Opportunity Costs - costs when taking one action requires giving up the opportunity to earn profits from a different action Incremental Costs or Differential Costs – additional costs incurred when choosing a certain course of action over another (Note that incremental costs can include opportunity costs Sunk Costs – Costs that have been incurred and that are not affected by any current/future action 25