ELEMENTS OF COST

MANISHA VERMA
COST
 COST: It may be defined as the monetary value of all
sacrifices made to achieve an objective (i.e. to produce
goods and services.
 The term ‘cost’ means the amount of expenses [actual or
notional] incurred on or attributable to specified thing or
activity.
 As per Institute of cost and work accounts (ICWA) India,
Cost is ‘measurement in monetary terms of the amount
of resources used for the purpose of production of goods
or rendering services.
ELEMENTS OF COST
Cost of production/manufacturing consists of various
expenses incurred on production/manufacturing of goods
or services.
These are the elements of cost which can be divided into
three groups : Material, Labour and Expenses.
 ELEMENTS OF COST
There are 3 major
elements of cost

Material Labour Expenses

Direct Indirect Direct Direct Indirect

Indirect
Material Material Labour Expenses Expenses
Labour
MATERIAL
To produce or manufacture material is required. For example
to manufacture shirts cloth is required and to produce flour
wheat is required. All material which becomes an integral
part of finished product and which can be conveniently
assigned to specific physical unit is termed as “Direct
Material”. It is also described as raw material, process
material, prime material, production material, stores material,
etc. The substance from which the product is made is known
as material. It may be in a raw or
manufactured state.
Material is classified into two categories:
 Direct Material

 Indirect Material
DIRECT MATERIAL
 Direct Material is that material which can be easily
identified and related with specific product, job, and
process. Timber is a raw material for making furniture,
cloth for making garments, sugarcane for making sugar,
and Gold/silver for making jewellery, etc are some
examples of direct material.
INDIRECT MATERIAL
 Indirect Material is that material which cannot be easily
and conveniently identified and related with a particular
product, job, process, and activity. Consumable stores,
oil and waste, printing and stationery etc, are some
examples of indirect material. Indirect materials are used
in the factory, the office, or the selling and distribution
department.
LABOUR
 Labour is the main factor of production. For conversion
of raw material into finished goods, human resource is
needed, and such human resource is termed as labour.
Labour cost is the main element of cost in a product or
service. Labour can be classified into two categories:
 Direct Labour, and

 Indirect labour
DIRECT LABOUR
 Labour which takes active and direct part in the
production of a commodity. Direct labour is that labour
which can be easily identified and related with specific
product, job, process, and activity. Direct labour cost is
easily traceable to specific products. Direct labour costs
are specially and conveniently traceable to specific
products. Direct labour varies directly with the volume
of output. Direct labour is also known as process labour,
productive labour, operating labour, direct wages,
manufacturing wages, etc. Cost of wages paid to
carpenter for making furniture, cost of a tailor in
producing readymade garments, cost of washer in dry
cleaning unit are some examples of direct labour.
INDIRECT LABOUR
 Indirect labour is that labour which can not be easily
identified and related with specific product, job, process,
and activity. It includes all labour not directly engaged in
converting raw material into finished product. It may or
may not vary directly with the volume of output. Indirect
labour is used in the factory, the office, or the selling and
distribution department. Wages of store-keepers, time-
keepers, salary of works manager, salary of salesmen,
etc, are all examples of indirect labour cost.
EXPENSES
 All cost incurred in the production of finished goods
other than material cost and labour cost are termed as
expenses.
Expenses are classified into two categories:
 Direct expenses, and

 Indirect expenses (An item of overheads)

DIRECT EXPENSES
 These are expenses which are directly, easily, and
completely allocated to specific cost center or cost units.
All direct cost other than direct material and direct
labour are termed as direct expenses.
 Direct expenses are also termed as chargeable expenses.
Some examples of the direct expenses are hire of special
machinery, cost of special designs, patterns, fee paid to
architects and consultants, inward carriage and freight
charges on special material, Cost of patents and
royalties.
INDIRECT EXPENSES
 These expenses cannot be directly, easily, and
completely allocated to specific cost center or cost units.
All indirect costs other than indirect material and indirect
labour are termed as indirect expenses.
 Indirect expenses are treated as part of overheads. Rent,
rates and taxes of building, repair, insurance and
depreciation on fixed assets, etc, are some examples of
indirect expenses.
OVERHEADS : MEANING
 The term overhead has a wider meaning than the term
indirect expenses.Overheads include the cost of indirect
material, indirect labour and indirect expenses. This is
the aggregate sum of indirect material, indirect labour
and indirect expenses.

Overhead = Indirect material + Indirect labour +

Indirect expenses
EXAMPLES OF INDIRECT MATERIAL,
LABOURS AND EXPENSES
 Indirect Materials:
(i) Grease, oil, lubricants, cotton waste etc.
(ii) Small tools, sundry supplies etc.
(iii) Cost of threads, gum, etc.
(iv) Consumable stores
(v) Factory printing and stationery
 Indirect Wages:
(i) Salary of factory manager, foremen, supervisors, clerks etc.
(ii) Salary of storekeeper
(iii) Salary and fee of factory directors and technical directors
(iv) Contribution to EPF., Leave pay etc. of factory employee.
 Indirect Expenses
(i) Rent of factory buildings and land
(ii) Insurance of factory building, plant, and machinery
(iii) Municipal taxes of factory building
(iv) Depreciation of factory building, plant and
machinery, and their repairs and maintenance charges
(v) Power and fuel used in factory
(vi) Factory telephone expenses.
CLASSIFICATION OF OVERHEADS
Overheads are classified into following three categories:
 Factory/works/ production overheads
 Office and administrative overheads
 Selling and distribution overheads
TOTAL COST

PRIME
OVERHEADS
COST

FACTORY
DIRECT OVERHEADS
MATERIAL

OFFICE
DIRECT OVERHEADS
LABOUR

DIRECT SELLING &

EXPENSES DISTRIBUTION
OVERHEADS
CLASSIFICATION OF COSTS
 According to Management Function
 According to Ease of Traceability

 According to Timing of Charge against Revenue

 According to Behavior in Accordance with Activity

 According to Relevance to Decision Making

ACCORDING TO MANAGEMENT FUNCTION

 Manufacturing costs – This cost incurred in the factory

to convert raw materials into finished goods. It includes
cost of raw materials used (direct materials), direct labor,
and factory overhead.

 Nonmanufacturing costs –The cost which is not

incurred in transforming materials to finished goods.
These include selling expenses (such as advertising
costs, delivery expense, salaries and commission of
salesmen) and administrative expenses (such as salaries
of executives and legal expenses).
ACCORDING TO EASE OF
TRACEABILITY

 Direct costs - those that can be traced directly to a

particular object of costing such as a particular product,
department, or branch. Examples include materials and
direct labor. Some operating expenses can also be
classified as direct costs, such as advertising cost for a
particular product.
 Indirect costs - those that cannot be traced to a
particular object of costing. They are also called
common costs or joint costs. Indirect costs include
factory overhead and operating costs that benefit more
than one product, department, or branch.
ACCORDING TO TIMING OF CHARGE AGAINST
REVENUE
 1. Variable costs - vary in total in proportion to changes
in activity. Examples include direct materials, direct
labor, and sales commission based on sales.
 2. Fixed costs - costs that remain constant regardless of
the level of activity. Examples include rent, insurance,
and depreciation using the straight line method.
 3. Semivariable costs - costs that vary in total but not in
proportion to changes in activity. It basically includes a
fixed cost potion plus additional variable costs. An
example would be electricity expense that consists of a
fixed amount plus variable charges based on usage.
ACCORDING TO RELEVANCE TO DECISION
MAKING

 1. Standard cost - predetermined cost based on some reasonable

basis such as past experiences, budgeted amounts, industry
standards, etc. The actual costs incurred are compared to standard
costs.
 2. Opportunity cost - benefit forgone or given up when an
alternative is chosen over the other/s. Example: If a business chooses
to use its building for production rather than rent it out to tenants, the
opportunity cost would be the rent income that would be earned had
the business chose to rent out.
 3. Sunk costs - historical costs that will not make any difference in
making a decision. Unlike relevant costs, they do not have an impact
on the matter at hand.
 4. Controllable costs - refer to costs that can be influenced or
controlled by the manager. Segment managers should be evaluated
based on costs that they can control.
METHODS OF COSTING:

 Different industries follow different methods for

ascertaining cost of their products. The method to be
adopted by business organisation will depend on the
nature of the production and the type of out put.
The following are the important methods of costing.
JOB COSTING:
 Job costing is concerned with the finding of the cost of
each job or work order. This method is followed by these
concerns when work is carried on by the customers
request, such as printer general engineering work shop
etc. under this system a job cost sheet is required to be
prepared find out profit or losses for each job or work
order.
CONTRACT COSTING:

 Contract costing is applied for contract work like

construction of dam, building,civil engineering contract
etc. each contract or job is treated as separate cost unit
for the cost ascertainment and control.The difference
between a job costing and a contract costing the duration
of job that is longer in contract costing.
BATCH COSTING:

 A batch is a group of identical products. Under batch

costing a batch of similar products is treated as a
separate unit for the purpose of ascertaining cost. The
total costs of a batch is divided by the total number of
units in a batch to arrive at the costs per unit. This type
of costing is generally used in industries like bakery, toy
manufacturing etc.
PROCESS COSTING:

 This method is used in industries where production is

carried on through different stages or processes before
becoming a finished product. Costs are determined
separately for each process. The main feature of process
costing is that output of one process becomes the raw
materials of another process until final product is
obtained. This type of costing is generally used in
industries like textile, oil refining etc.
SERVICE (OPERATING) COSTING:

 This method is used in those industries which rendered

services instead of producing goods. Under this method
cost of providing a service is also determined. It is also
called service costing. The organisation like water supply
department, electricity department, education department
etc. are the examples of using operating costing.
MULTIPLE COSTING:

 It means combination of two or more of the above

methods of costing. Where a product comprises many
assembled parts or components (as in case of motor car)
costs have to be ascertained for each component as well
as for the finished product
for different components, different methods of costing
may be used. It is also known as composite costing. This
type of costing is applicable to industries producing
motor vehicle, aeroplane radio, T.V. etc.