ELEMENTS OF COST

A cost is composed of three elements- Material, Labour and Expenses. Each of these can be
either direct or indirect.
COST

Material Expenses
Labour

Direct Indirect Indirect

Direct Direct Indirect
Materials Cost
The first element of the cost of the product is raw material. Material form an important part of
the cost of a product and therefore proper control over materials is necessary. The term materials
generally used in manufacturing concerns, refers to raw materials used for production, sub-
assemblies and fabricated parts. Material cost may be further classified into two parts-
i) Direct Material Cost
ii) Indirect Material Cost
Direct Material Cost
Direct Materials are those which can be identified in the product and which can be measured and
directly charged to the product.
In the manufacture of a product, different types of materials are consumed. These comprises of
raw materials, spares and components, consumable stores, packing materials etc. Examples of
Direct Material are timber in furniture making, cloth in dress making and pig iron in foundry.
However, in many cases though the material forms a part of the finished product, yet it is not
treated as direct material e.g. sewing thread in dress making, and nails in furniture making.
Similarly, there are also cases where the materials do not enter or form a part of the finished
product, they are treated as direct material e.g. sand used in foundry, spirit used in varnishing of
furniture. In general, the following are normally classified under direct materials:
(i) All materials specially purchased for a specific product or process. Such as starch powder
for dressing of yarn.
(ii) All materials components and parts such as batteries for transistors radios, and tyres for
bicycles.
(iii)All raw materials such as clay in bricks, leather in shoes and fruits in the canning
industry.
(iv) All raw materials issued from stores
(v) All raw materials passing from one process to another
(vi) Basic or essential packing materials such as cartoons, craft paper, cellophane paper, etc.
Thus, in judging what is a direct material, due consideration must be given to the nature of
the material, its use in the manufacturing process and its impact on the total cost of the
product. Moreover Direct Material is also known as production Materials, Process Material,
Prime Cost Material and Convertible Material.
Indirect Material Cost
Materials Cost which cannot be allocated, but which can be apportioned to or absorbed by
cost centre’s or cost units is termed as indirect material cost. The cost of indirect materials is
collectively ascertained for a department or process and then suitably absorbed over the
products on an equitable basis. In fact, these materials are those (i) which are minor in
importance, small, and inexpensive and may become a part of the finished product e.g.
thread, screws, nut & bolts, pins etc. and (ii) which do not physically become a part of the
finished products e.g. lubricating oil and grease, coal, sand paper, soap, gum etc. In this way
indirect material cost is the cost of materials which cannot be allocated but which can be
apportioned to or absorbed by cost centres or cost units. Generally indirect materials are:-
(i) Materials which are not considered as direct materials due to their small cost.
(ii) Stores and supplies used in the maintenance of machinery, building etc, like lubricants,
cotton waste, belting, bricks and cement etc.
(iii)Stores and supplies used by service department i.e. non-productive departments like
power house, boiler house, canteen, etc.
LABOUR COST
Labour forms the second most important element of cost in most industries and business.
Unlike materials or other tangible assets labour is a non-material service performed by
human beings. The services which labour represents cannot be conserved or inventoried. In
many industries where skill and quality is the first criterion, labour is sometimes becomes the
most important factor and constitutes the largest element of cost.
From the control point of view labour costs can be classified by cost centre (departmental
labour), accountability heads (function), or by-product or output on the basis of incidence. It
is possible to related costs or idle or wasted labour costs. On the basis of accounting, labour
is classified as direct or indirect, general or work charged, depending on the degree of
identification of such labour costs with the related jobs or operations.
Direct Labour Cost
Direct labour cost means the wages which can be allocated to cost centre’s or cost units. It
may be defined as all labour expended in altering the construction, composition,
conformation or condition of the product……….it consists of wages paid to workers directly
engaged in converting raw materials into finished product, job or process. Wages paid to a
machine operator, baker, shoe-maker, carpenter, weaver, tailor etc. are the examples of direct
labour cost. In some cases, where the circumstances so warrant, the wages paid to
supervisors, inspectors, department etc., are also treated as direct labour if they are directly
engaged on one specific product or process and the hours they spend on it can be directly
measured without much of an effort.
The Direct Labour is also known as direct wages, productive wages, manufacturing wages,
operating wages and prime labour cost.
Indirect Labour Cost
In any manufacturing process or department, those workers who are aiding the
manufacturing, by way of supervision, maintenance, tool setting, transportation of materials
etc., constitute indirect labour and their wages are termed as indirect labour cost. In other
words, indirect labour is not directly engaged in the production operations but only to assist
or help in production operations.Examples of indirect labour costs are wages payable to
foremen, inspectors, watchman, supervisors, factory clerks, store-keepers, maintenance
workers, security officers and time-keepers etc. Thus, there are many factors which influence
the concept of direct and indirect labour. For example, a machine operator’s work is
generally direct wages but time spent by a machine operator in repair or clean-up work is
indirect wages. So, in different circumstance the same work can be classified as direct or
indirect.
EXPENSES
Expenses’ are the third element of cost which can be defined as the cost of service provided
to an undertaking and the notional cost of the use of owned assets. Thus, all cost other than
material and labour are termed as expenses. Expenses may thus be described as ‘’Gone
Assets’’ i.e., as benefits or resources used up in the process of securing revenue. Expenses
may be direct or indirect.
Direct Expenses
These are those Expenses which are specifically incurred in connection with a particular job
or cost unit. It is defined as ‘’Expenses which can be identified with and allocated to cost
centre’s or cost units. Direct Expenses include any expenditure other than direct material and
direct labour directly incurred on a specific cost unit. These are sometimes also known as
chargeable expenses, expenses of such expenses are hire of special plant for a particular job,
cost of patents and royalties, carriage paid for materials purchased for a specific job and
travelling expenses in securing a particular contract etc.
Indirect Expenses
The term Indirect Expenses covers all indirect expenditure incurred by the manufacturing
enterprise from the time production as started to its completion and transfer to the finished
goods to the stores. All expenses which have not classified as direct expenses are termed as
indirect expenses. It may be defined as ‘’Expenses which cannot be allocated to cost centre’s
or cost units but which can be apportioned or absorbed by cost centre’s or cost unit.
Examples of indirect expenses are rent and rates, carriage, insurance, depreciation, Lighting
and power and advertising etc.
Works or Factory Overheads
Works overheads include all indirect costs incurred by the manufacturing department from
the receipt of raw material until the product is finished and placed in a saleable condition. It
includes indirect materials, indirect labour and indirect expenses relevant with producing
goods or services. Works overheads are also known as production overheads, manufacturing
overheads, factory overheads, and works on cost, works indirect expenses, indirect factory
expenses etc. Thus, these are those indirect costs or overheads which are concerned with the
production function or manufacturing function. Examples of these overheads are as follows:
1. Indirect Material used in the Factory:
(i) Cost of rags, cotton waste, machine oil, grease etc., lubricating oil or cost of
consumable stores.
(ii) Cost of materials of small value, it is quite difficult and futile to measure them,
e.g., cost of nails used in furniture manufacturing, nails, thread etc. used in shoe
making.
(iii) Stores consumed for repairs and maintenance work.
(iv) Sundry stores of small value expended for factory use
(v) Small tools for general use
(vi) Deficiencies, loss and deterioration of stores.
2. Indirect Labour Cost in the Factory:
(i) Wages of indirect labour or non-productive or non-manufacturing wages.
(ii) Salaries of foreman.
(iii) Salaries of inspectors and supervisors
(iv) Salaries of store-keeper and time-keepers
 (v) Wages of factory watchmen, machine cleaners, repairs & maintenance workers
(vi) Wages of crane drivers and materials transport workers
(vii) Salaries of clerical and technical staff of stores and other service departments of
the factory.
(viii) Salary of works manager
(ix) Fees of technical directors
(x) Cost of idle time of factory labour
(xi) Workmen’s compensation and contribution to funds
(xii) Over-time and night shift bonus and play not included in direct wages.
(xiii) Holiday and leave pay
(xiv) Miscellaneous allowances to labour.
3. Other Indirect Factory Expenses:
(i) Factory Rent, Rates and Insurance
(ii) Power and fuel used for machines
(iii) Lighting and heating of factory building
(iv) Depreciation and repairs and factory building
(v) Depreciation, repairs and insurance of plant and machine
(vi) Printing, stationary and telephone expenses of factory office
(vii) Drawing office expenses
(viii) Factory canteen and other labour welfare expenses
(ix) Factory experimental and research expenses
(x) Training expenses of factory workers and employees
(xi) Hospital and dispensary expenses
(xii) Expenses of factory service department e.g. Purchase Department, Stores, Tools
Department, Engineering and Maintenance Department, Power House, Labour
Department etc.
Office and Administrative Overheads
Office and administration overheads are the indirect costs incurred in general
administrative function. This includes all expenses incurred in the direction, control and
administration (including secretarial accounting and financial control) of an undertaking.
It may be defined as the cost of formulating the policy, directing the organization and
controlling the operations of an undertaking, which is not related directly to a production,
selling, distribution, research or development activity or function. These overheads are
also known as office indirect expenses, establishment overhead, office on cost etc.
Examples of these overheads are as follows:
(i) Depreciation, Repairs and Insurance of Office Building, Office Furniture and
Office Equipment
(ii) Salaries of Office Staff
(iii) Salaries and Fees of Administrative Directors
(iv) General Manager’s Salary
(v) Printing, Stationery, Postage and Telephone Expenses
(vi) Rent, Rates & Taxes and Insurance of Office Building
(vii) Office lighting, heating and cleaning expenses
(viii) Office Air-conditioning expense
(ix) Audit fees or legal expenses
(x) Office expenses or Establishment expenses, Sundry expenses or General expenses
(xi) Bank charges
(xii) Director’s travelling expenses

Selling Overheads
All expenses incurred in obtaining and retaining a customer is classified as selling
overheads. It is defined as the expenditure incurred in promoting sales and
retaining customers. Thus, selling cost is the cost of seeking to create and
stimulate demand (sometimes termed as marking) and securing orders. It is also
known as selling on cost. Examples of these overheads are as follows:
(i) Advertisement
(ii) Salaries of sales and publicity staff
(iii) Salaries of salesmen and sales representatives, commission, brokerages
etc. on sales.
(iv) Sales office expenses
(v) Salaries and commission of sales manager
(vi) Travelling expenses of salesmen
(vii) Depreciation, repairs, maintenance and insurance of sales office, furniture
and equipment
(viii) Stationery, postage, telephone expenses of sales department
(ix) Expenses of branches and agencies
(x) Decoration expenses of show-rooms
(xi) Cost of preparing tenders and estimates
(xii) Cost of price lists, circulars and samples
(xiii) Rent and insurance of show-rooms
(xiv) Stock shortage
(xv) Bad Debts

Distribution Overheads
Distribution overheads are expenses incurred from the stage the product is sent to
the finished goods store and ends with the repairs and reconditioning of empties
and containers, ready for re-use. Thus, distribution overheads include all
expenditure incurred from the time the product is completed until it reaches its
destination. It refers to all expenses incurred in executing orders. It is also known
as distribution on cost. Examples of these overheads are as follows:
(i) Rent of warehouse
(ii) Carriage outward and other transport charges
(iii) Depreciation, Repair, Insurance and Expenses for Upkeep of Delivery
Vans
(iv) Petrol expenses of Delivery Vans
(v) Salary and Allowances of Drivers of Delivery Vans
(vi) Salary of warehouse staff
(vii) General Packing Expenses and Packing Materials
(viii) Wastage and Goods in Transit
(ix) Repairs and maintenance expenses of Packing material and cases
(x) Rent, Repairs, Insurance and General Expenses of Dispatch Department
and Warehouse
(xi) Carriage on returns due to defective packing.
 Different Components of Total Cost
On the basis of elements of cost discussed as above, the different components of total cost may
be summarized as follows:

1. Prime Cost:
Direct Material × ××
Direct Labour × ××
Direct Expenses × ××
Prime Cost × ××
It is also known as Flat Cost, First Cost or Direct Cost.
2. Works Cost:
Prime Cost × ××
Add: Factory Overheads
Or Works overheads or Manufacturing
Overheads or Factory on cost or
Or Factory Indirect cost × ××
Works Cost × ××
It is also known as Factory cost or Manufacturing cost or Production cost.

3. Office Cost:
Works Cost × ××
Add: Office and Administration overheads × ××
Office Cost × ××
It is also known as Cost of Production or Gross Cost.
4. Cost (of production) of goods sold:
Cost of Production × ××
Add: Opening stock of Finished Goods × ××
× ××
Less: Closing stock of Finished Goods × ××
Cost of Goods Sold × ××
5. Total Cost or Cost of Sales:
Cost (of production) of goods sold × ××
Add: Selling and Distribution overheads × ××
Total Cost or Cost of Sales × ××
6. Profit/Loss:
Sales × ××
Less: Total Cost or cost of sales × ××
Profit/Loss × ××