Elements of cost

Elements of cost

The basic elements of cost should be learnt in order to understand the correct interpretation of the term, “cost”. There are broadly three elements of cost:

Material: The substance from which the product is made is known as material and it may be in a raw or a manufactured state. It can be direct as well as indirect.

Direct material: All material which becomes an integral part of the finished product and which can be conveniently assigned to specific physical units is termed as “direct material” and the following are some of the examples of direct material:

All material or components specifically purchased, produced or requisitioned from stores; Primarily packing material (e.g. carton, wrapping, cardboard, boxes etc) Partly produced or purchased components

Indirect material: All materials which are used for purposes ancillary to the business and which cannot conveniently be assigned to specific physical units, are termed as “indirect materials”. Consumable stores, oil and waste, printing and stationery material etc. are a few examples of indirect material.

Labour: For conversion of materials into finished goods, human effort is necessary and such human effort is called as labor and labor can be direct as well as indirect.

Direct labor: The labor which takes an active and direct part in the production of a particular commodity is called as direct labor and direct labor costs are, therefore, specifically and conveniently traceable to specific products.

Indirect labor: Labor employed for the purpose of carrying out tasks incidental to goods produced or services provided is indirect labor and such labor does not alter the construction, composition or condition of the product and it cannot be practically traced to specific units of output. Wages of store keepers, foremen, time keepers, directors’ fees, salaries of salesmen etc. are all examples of indirect labor costs.

Expenses: Expenses may be direct or indirect.

Direct expenses: These are expenses which can be directly, conveniently and wholly allocated to specific cost centers or cost units. Examples of such expenses are: hiring of some special machinery required for a particular contract, cost of defective work incurred in connection with a particular job or contract etc.

Indirect expenses: These are expenses which cannot be directly, conveniently and wholly allocated to cost centers or cost units. Examples of such expenses are rent, lighting, insurance charges etc.

Overheads: The term overhead includes indirect material, indirect labor and indirect expenses. Thus, all indirect costs are overheads.

A manufacturing organization can broadly be divided into three divisions:

Factory or works, where production is executed; Office and administration, where routine as well as policy matters are decided and Selling and distribution, where products are sold and finally dispatched to the customers.

Overheads may be incurred in the factory or office or selling and distribution divisions and thus overheads may be of three types:

Factory overheads: They include:

Indirect materials used in the factory such as lubricants, oil, consumable stores etc., Indirect labor such as gate keeper’s salary, time keeper’s salary, works managers’ salary etc., Indirect expenses such as factory rent, factory insurance, factory lighting etc.

Office and administration overheads may include indirect materials used in the office such as printing and stationery material, brooms and dusters etc; indirect labor such as salaries payable to office manager, office accountant, clerks etc; indirect expenses such as rent, insurance, lighting of the office.

Selling and distribution overheads include indirect materials used such as packing material, printing and stationery material etc., indirect labor such as salaries of salesmen and sales manager etc; and indirect expenses such as rent, insurance, advertising expenses etc.

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