Elements in costing mean the components of parts of the total cost of a particular product or service. In other words, elements of cost are the items of expenses incurred when producing a product or service. Cost comprises of three elements, they are:
Each cost elements will be explained later in this article. By grouping these elements following divisions of cost are obtained:
1. Prime Cost = Direct Material + Direct Labour + Direct Expenses.
2. Factory / Works Cost = Prime Cost + Factory / Works Overheads.
3. Cost of Production = Factory / Works Cost + Office / Administration Overheads.
4. Cost of Sales or Total Cost = Cost of production + Selling and Distribution Overheads.
ELEMENT 1. MATERIAL:
Materials means all commodities consumed in the manufacturing process. We can also use materials as inventory. The term inventory comprises of raw material, work-in-progress and finished goods. Raw materials are the commodities which are consumed in the production process and they are the basic commodities used for production. Work-in-progress are the commodities which are in the production process but they have not taken a final shape. lastly, finished goods are the manufactured components which are ready to be consumed or be put for sale.
Furthermore, materials can be classified into two:
1. Direct materials
2. Indirect materials.
Direct materials are the materials which can be traced and charged to every unit of the product. Examples of direct materials are cloth needed to make a shirt, tobacco in cigarette, wood used in producing table. However in some cases, though material forms a part of finished product, yet it is not treated as direct material as its value is quite small and it is quite difficult and futile to measure it. Examples are thread used in a stitching a shirt or a nails used in furniture.
Indirect materials on the other hand is the opposite of direct materials. They are those materials which cannot be traced or identified with the cost unit or product. They are not very important as they are relatively less in value. Examples of indirect materials are thread, oil, stationery etc.
ELEMENT 2. LABOUR:
Labour is an important element of cost. It represents the human contribution to production. Labour can be classified as direct or indirect labour. Direct Labour is that labour which can be easily identified or traceable to the creation of a product. Direct labour cost consists of wages paid to the workers who are directly engaged in production process. Example of direct labour is the wages paid to a worker who produces a plate.
Indirect Labour is that which cannot be easily traceable with a particular cost unit. Indirect labour is one who are not directly engaged in production but only assist the main worker in converting raw materials to finished goods. An example of indirect labour is helper
ELEMENT 3. EXPENSES:
All costs which are not material and labour are called expenses. According to CIMA, expenses are defined as “the cost of services provided to an undertaking and the notional cost of the use of owned assets”. Expenses are classified into direct and indirect. Direct Expenses are those expenses which can have direct identification with production. These expenses are incurred specifically in connection with a particular job or cost unit. Direct expenses are called chargeable expenses and form part of prime cost. Examples are hire charges for purchase of equipments, royalties etc. Indirect Expenses are those which cannot be directly identified with a particular job or process. Examples are factory rent, repairs and maintenance etc.
Prime Cost are expenditures which can be charged directly to a particular unit of product. It is the aggregate of direct material, direct labour and direct expenses. It is called Prime cost because a major portion of the total cost is involved in this cost ranging from 40% – 70%.
ELEMENT 4. OVERHEADS:
Overhead is the total of all indirect costs incurred in production process. They include indirect material, indirect labour and indirect expenses.
Overheads are again classified into:
i. Factory overheads
ii. Office overheads
iii. Selling and distribution overheads.
I. FACTORY OVERHEADS:
Factory or Work Overheads are those which are connected with the manufacturing function. It includes:
(a) Indirect material such as Cotton waste, lubricants, stationery used in office etc.
(b) Indirect wages such as salary of factory staff, supervision, inspection, work manager’s salary etc. and
(c) Indirect expenses such as factory rent, repairs and maintenance, depreciation on plant and machinery, power, factory lighting etc
II. OFFICE OVERHEADS:
These are the administrative expenses incurred in making polices in the administrative office. These expenses are not traceable to production or sales.
Again these overheads can be classified into:
(a) Indirect material such as stationery used in general administration, postage, printing etc.
(b) Indirect labour like salary of office staff, remuneration to directors of the company etc.
(c) Indirect expenses such as office lighting, depreciation of office equipments, rent of office building, telephone expenses, etc.
III. SELLING AND DISTRIBUTION OVERHEADS:
Selling overheads are incurred to promote the sales and expand the market, while distribution overheads includes expenses incurred to supply the product from stores to the market. They are the cost of warehousing, transport, material handling and control of finished goods from the moment they leave the factory to the moment they are delivered to the customer. Examples of selling and distribution expenses are carriage outwards, packing materials, warehouse etc.
They are further classified into:
(a) Indirect material such as packing material, cost of samples, price list, stationery used in the sales office, oil used for delivery vans etc.
(b) Indirect labour such as salary of sales manager, salary of sales staff, salary of drivers etc.
(c) Indirect expenses such as advertising, rent of warehouse, insurance of goods travelling expenses, carriage outwards, bad debts etc.