Fundamentals of Cost Accounting

Elements of Cost

The elements of cost are those elements which constitute the cost of manufacture of a product. We can broadly divide these elements of cost into three categories. In a manufacturing organization, we convert raw materials into a finished product with the help of labor and other services. These services are Material, Labour and Expenses.

Elements of Cost

Again, we can bifurcate these elements of cost into two categories such as Direct Material and Indirect Material, Direct Labour and Indirect Labour, Direct Expenses and Indirect Expenses. We need to add all direct material, direct labor, and direct expenses to calculate the prime cost.

Likewise, we add all indirect material, indirect labor, and indirect expenses to calculate the overhead cost. Again, we can bifurcate the overheads into four categories. They are factory overhead, administrative overhead, selling overhead and distribution overhead.

1. Direct Material

It represents the raw material or goods necessary to produce or manufacture a product. The cost of direct material varies according to the level of output. For example, Milk is the direct material of ghee.

2. Indirect Material

It refers to the material which we require to produce a product but is not directly identifiable. It does not form a part of a finished product. For example, the use of nails to make a table. The cost of indirect material does not vary in the direct proportion of product.

Learn more about Meaning of Cost, Costing and Cost Accounting here in detail

3Direct Labour

It refers to the amount which paid to the workers who are directly engaged in the production of goods. It varies directly with the level of output.

4. Indirect Labour

It represents the amount paid to workers who are indirectly engaged in the production of goods. It does not vary directly with the level of output.

5. Direct Expenses

It refers to the expenses that are specifically incurred by the enterprises to produce a product. The production cannot take place without incurring these expenses. It varies directly with the level of production.

6. Indirect Expenses

It represents the expenses that are incurred by the organization to produce a product. These expenses cannot be easily identified accurately. For example, Power expenses for the production of pens.

Elements of cost

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7. Overhead

It refers to all indirect materials, indirect labour, or and indirect expenses.

8. Factory Overhead

Factory overhead or Production Overhead or Works Overhead refers to the expenses which a firm incurs in the production area or within factory premises.

Indirect material, rent, rates and taxes of factory, canteen expenses etc.are example of factory overhead.

9. Administration Overhead

Administrative or Office Overhead refers to the expenses which are incurred in connection with the general administration of the organizations.

Salary of administrative staff, postage, telegram and telephone, stationery etc.are examples of administration overhead.

10Selling Overhead

All expenses that a firm incurs in connection with sales are selling overheads. Salary of sales department staff, travelers’ commission, advertisement etc.are example of selling overhead.

11Distribution Overhead

It represents all expenses incurred in connection with the delivery or distribution of finished goods and services from the manufacturer to the consumer. F Delivery van expenses. loading and unloading, customs duty, the salary of deliverymen are examples of distribution overhead.

Solved Example for You

Specify items which are generally classified as direct materials?

Ans:

Following are normally classified as direct materials:

(i) All raw materials like plastic in the manufacture of bottles, yarn in clothes, and iron in the steel industry.

(ii) Materials specifically acquired for a specific job, process or order like adhesives for bookbinding, starch powder for dressing yarn.

(iii) Parts or components acquired or produced like cartage for printer and tires for cars.

(iv) All materials used in primary packing like cartons, wrappings, cardboard boxes, etc. to protect finished goods from climatic conditions or for easy handling inside the factory.

From the above discussion, it becomes clear that indirect materials are those materials which cannot be treated as direct materials. Consumables, like the cotton waste, lubricants, brooms, rags, cleaning materials, materials for repairs and maintenance of fixed assets, are examples of indirect materials.

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