Elements of

cost

Introduction:
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)

Introduction continuation

It is basics in cost accounting. If you know elements of

cost, you can try to collect them for finding the cost of
product.
Element of cost provides the complete structure in which
we can identify our total cost.
For example, you go to market and buy one packet of tiger
biscuit by paying Rs. 5. But this price's major part is the
cost of packet.
Manufacturer made this packet of biscuit by purchasing its
raw material, producing by the help of machines and
labours and delivered you by any transport means.
All these things have some cost and these cost will be
element of cost in simple words.

Classification of costs

According to
Nature
Function
Behaviour
Identifiably
Association with products
Controllability
Normality
Time
Relevance and
Other costs

According to nature of elements

One of the main functions of cost accounting is

to classify the costs. Costs may be classified
according to its elements. We can distinguish
three basic elements in the manufacturing cost
of any product or services.

The three main elements of costs are

Material
Labour
Expense

Material cost Direct Materials

Indirect Materials
5

Direct materials

Also known as Productive materials,

it is the cost of the material that enter into and forms a

part of the product

it is essential for the completion of the product
Examples:

Timber in furniture making and clay in brick making,

HSS bit for making turning tool
Ni, Fe, Cr etc for making alloy steels

Indirect materials
Essentially needed to convert the raw materials into final

products but not used directly in the product itself.

Eg. coolants, grease, cotton waste , thread, nail, gum,
fuel, etc
The cost associated with indirect material is called
indirect cost

Classifications of
Manufacturing Costs
Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

The Product

Manufacturing
Manufacturing
Overhead
Overhead

Direct Materials
Raw materials that become an integral part of
the product and that can be conveniently
traced directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile

Labour cost

Cost of remuneration of the

employees of an organization. Such
as wages, salaries, bonus,
commissions etc.

Types:
Direct labour cost
Indirect labour cost

10

Direct labour cost

The cost of labour that can be directly

associated with the manufacture of the product
and can be allocated to cost centers and cost
units.
A direct labour is one who converts the direct
material into a saleable product and the
expenses incurred on such labour is called
direct labour cost
The direct labour cost may be apportioned to
the unit of the cost or on the basis of the time
spent by the worker or as the price for some
physical measurement of the product

11

Direct Labor
Those labor costs that can be easily traced
to individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers

Indirect labour cost

The cost of the labour that does not alter

the construction, composition,
conformation, or the condition of the
direct material but is necessary for the
progressive movement and handling of
the product to the point of dispatch.
This cost is absorbed by the cost
centers and cost units.
Eg. Maintenance men, helpers, machine
setters, supervisors, foremen etc.
13

Expenses

Its a collective title which refers to all

charges other than those incurred as
a direct result of employing workers
or obtaining material.
Types:
Direct expenses
Indirect expenses

14

Direct expense

Expenses that can be identified with and

allocated to cost centers /cost units
Eg: Costs of special layouts, designs, drawings, for

a special job
Hiring special purpose machines or equipments
for a particular production order

Indirect Expense:

Expenses absorbed by cost centers or cost

units
Eg: building rent, Insurance, phone bills etc.

15

Fixed expense

Costs that remain fixed independent

of the volume of production
Eg: land tax, water tax, building tax,

depreciation, rent , insurance, salary etc.

Variable expense:

Costs that vary directly with volume of

production.
Eg: electricity, wages for contract labour,

consumables, raw material cost etc..

16

Prime cost

Direct material cost + Direct labour

cost + (Variable) Direct expenses

Note: Prime cost is limited in its use

to manufacturing division of a
business concern

17

Overheads

All expenses other than direct expenses

Definition.: cost of indirect material, indirect
labour and other indirect expenses including
services.
Overheads are subdivided into
Manufacturing overheads,
Administrative overheads
Selling overhead
Distribution overhead
R & D overhead

18

Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.
Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor

i) Manufacturing
overhead

All indirect expenses incurred by the company

from the receipt of production order to its
completion for despatch to the customer

Typical mfg overheads are

1. Building expenses rent, insurance, repairs,

heating and lighting, depreciation etc.

2. Indirect labour supervisors, foremen, machine
setters, general workers, maintenance men, shop
clerks, shop inspectors etc.

20

Continued :3. Water, fuel, power

4. Consumables like cotton waste, grease

etc.
5. Plant maintenance and depreciation
6. Expenses such as security, employment
office, welfare measures, recreation
facilities, restrooms etc.

21

Nonmanufacturing Costs
Administrative
Costs

All executive,
organizational, and
clerical costs.

ii) Administrative
overhead

Expenses incurred in direction, control,

administration of an enterprise.
It is the expense of providing a general
management and clerical service
Eg: rent, salaries of clerks, salaries of

directors, GM etc, insurance, legal costs,

taxes, postage, telephone, audit fees, bank
charges, etc.

23

iii) Selling overhead

Expenses required to maintain and

increase volume of sales
All expenses direct or indirect necessary
to persuade consumers to buy
Advertising
Salaries and commissions for sales people
Showroom rent
After sales service cost etc.

24

iv) Distribution overhead

Expenses connected with storing and

transportation to customers
Warehouse charges
Transportation of goods
Loading and unloading charges
Maintenance of delivery vehicles
Depreciation of vehicles etc

25

R & D overhead

Expenses on research
Expenses on product development

Factory Cost:
= Prime cost + factory overhead
= direct material cost + direct labour cost +
(variable) direct expenses + factory
overhead

26

Total cost =

Factory cost
+ selling overhead
+ distribution overhead
+ administrative overhead

Selling Price = total cost + profit or loss

27

Nature of cost

Fixed cost
Variable cost
Semi variable cost
Controllable cost
Uncontrollable cost

SUMMARY :--

Selling Price
Profit or Loss

Total Cost

Production
Cost

Selling
Overhead

Distribution Overhead

Factory Cost Administrative Overhead

Prime Cost

Factory or Production Overhead

Direct Material Cost + Direct Labor Cost +

(variable) Direct Expenses

Example :- From the following data, find

(a) Material cost
(b) Prime cost
Direct cost
(d) Factory cost
(e) Administrative overheads
(f) Cost of production
(g) Selling and distribution overheads
(h) Total cost or cost of sales
(i) Selling price
Assume a net profit of Rs. 10,000.

30

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22

Material in hand (April 1, 1975)

material purchased
Directors fees
Advertising, etc.
Depreciation on sales department car
Printing and stationary charges
Plant depreciation
Wages of direct workers
Wages of indirect (factory) workers 10,000
Rent of factory building
Postage, telephone and telegraph
Water and electricity for factory
Office salaries
Rent of the office
Rent of the show room
Commission of salesman
2,500
Sales department car expences
Material in hand (March 31, 1976)
Variable direct expenses
Plant repair and maintenance
Heating, lighting and water for office use
Cost of distributing goods
2,000

Rs.
60,000
2,50,000
3,500
12,000
1,200
300
5,000
70,000
5,000
200
1,000
2,000
500
1,500
1,500
50,000
750
3,000
2,500
31

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22

Rs.
Type of cost
Material in hand (April 1, 1975)
60,000 Direct cost
New material purchased
2,50,000 Direct cost
Directors fees
3,500
Administrative overhead
Advertising, etc.
12,000 Selling & Distribution overhead
Depreciation on sales department car
1,200
Selling & Distribution overhead
Printing and stationary charges
300
Administrative overhead
Plant depreciation
5,000
Factory or Production overhead
Wages of direct workers
70,000 Direct cost
Wages of indirect (factory) workers 10,000 Factory or Production overhead
Rent of factory building
5,000
Factory or Production overhead
Postage, telephone and telegraph
200
Administrative overhead
Water and electricity for factory
1,000
Factory or Production overhead
Office salaries
2,000
Administrative overhead
Rent of the office
500
Administrative overhead
Rent of the show room
1,500 Selling & Distribution overhead
Commission of salesman
2,500
Selling & Distribution overhead
Sales department car expences
1,500
Selling & Distribution overhead
Material in hand (March 31, 1976)
50,000
Direct cost (-)
Variable direct expenses
750
Direct cost
Plant repair and maintenance
3,000 Factory or Production overhead
Heating, lighting and water for office use
2,500
Administrative overhead
Cost of distributing goods
2,000 Selling & Distribution overhead
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Solution :
(a)Material cost
= Cost of material in hand on April 1, 1975
- Cost of material in hand on March 31, 1976
+ Cost of new material purchased
= 60,000 50,000 + 2,50,000 = Rs. 2,60,000
Prime Cost
= Direct material cost
+ Direct labor cost
+ direct expenses
= 2,60,000 + 70,000 + 750 = Rs. 3,30,750
Direct Cost
It is same as Prime Cost
(d) Factory Cost
=Prime cost Production overhead (Sl.no. 7,9,10,12,20)
= 3,30,750 + 5,000 + 10,000 + 5,000 + 1,000 + 3,000
= Rs. 3,54,750
(b)

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(e) Administrative Overheads (Sl.no. 3,6,11, 13, 14, 21)

= 3,500 + 300 + 200 + 2,000 + 500 + 2,500 = Rs. 9,000
(f) Cost of Production = Factory Cost + Administrative overhead
= 3,54,750 + 9,000 = Rs. 3,63,750
(g) Selling & Distribution Overhead (Sl.no. 4, 5, 15, 16, 17, 22)
= 12,000 + 1,200 + 1,500 + 2,500 + 1,500 + 2,000
= Rs. 20,700
(h) Total Cost or Cost of Sales
= Cost of production + Selling & Distribution overhead
= 3,63,750 + 20,700 = Rs. 3,84,450
(i) Selling Price = Cost of sales + Profit
= 3,84,450 + 10,000 = Rs. 3,94,450

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Problem

Calculate the selling price of one fountain pen from data

given below.
No. of fountain pens
=
135
Labour cost
=
Rs.200
Material cost
=
Rs.160
Factory overheads
=
35% of Prime cost
Administration & selling
overheads
=20% of
factory cost
profit
=
10% of total cost

Problem

A drill press costs Rs.6,000. A discount of

25% of this price is given to the distributor. If
labour cost, Material cost and factory
overheads are as 4:1:2; and selling
expenses are 25% of the factory cost,
calculate the profit of the factory for one drill
press. Assume factory overheads of Rs.800.

Problems :A factory producing 150 electric bulbs a day, involves direct

material cost of Rs.250, direct labour cost of Rs.200 and
factory overheads of Rs.225. Assuming a profit of 10% of
the selling price and selling on cost (overhead) 30% of
the factory cost, calculate the selling price of one electric
bulb.
Solution :Factory cost = Direct material cost + Direct labour cost +
Factory overheads
= Rs.250 + 200 + 225 = Rs. 675
Total cost = Factory cost + Selling overhead (i.e., on cost)
= Rs.675 + Rs. 675 X 30 / 100
= Rs. 877.50 (i)

Continue :Also, Total cost = Selling price Profit

= S.P. -- S.P. X 10/100 ..(ii)
Equating (i) and (ii) above
S.P. S.P. X 10/100 = Rs. 877.50
Therefore,
Selling price = Rs. 975
Hence the selling price of one electric bulb
= Rs. 975 / 150
= Rs. 6.50