Elements Of Cost: Material Cost, Labor Cost, And Expenses.

Material cost

Three main elements of cost of product or services are Material cost, Labour cost and expenses.

This cost includes funds by the organisation in production of goods. Any substance used to in manufacturing of product can be considered as material and thus material can be in raw form or finished products which are used in manufacturing of another product. Material cost can be direct or indirect.

Direct Material cost: Direct material can be defined as any material which is used as an integral part in production finished goods and which can be allocated to any particular cost centre. Raw material purchased or packing material purchased for primary packing of finished goods are some example of direct material cost.

Indirect Material cost: Cost which is not directly attributable to any individual cost centre and are used for ancillary purpose of the business can be defined as indirect cost.Oil used in machines, Stationary, consumable stores are common examples of indirect cost of material.

Labour cost

Individual efforts done by a person to convert raw material into finished goods is termed as labour. This cost is incurred in form of wages paid to employees or labour of the organisation. Labour cost can be classified into direct and indirect labour.

Direct Labour cost: Cost of employees who are directly linked with the manufacturing of the product is called direct labour cost. This cost can be directly attributed to individual cost centre. Wages, salary, bonus, overtime payment made to direct labour are example of this cost.

Indirect labour cost: This cost is incurred on those employees who are not a part of manufacturing process and carry out task incidental to goods produced or services rendered. This cost may be incurred in office, factory or selling and distribution division. Few examples of indirect labour cost are salary of office personnel, Director’s fees, wages paid to store keeper.

Expenses

Cost of service provided to the organisation is termed as expenses. It can again be classified as direct expense and indirect expense.

Direct Expense: Any expense which can be directly allocated to a particular job, product or service is known as direct expense. For example: Hire charges of machine, cost of defective work for a particular contract.

Indirect expense: These are those expenses which are not be attributable to any individual cost centre. They are common expenditure and can be distributed to various cost centres proportionately. Rent of a factory, electricity bill, selling and distribution expense are some example of indirect expenses.

Direct material cost

Detailed recording of cost is required for determining the unit cost of the product by examining all the resources used in the production of that product. This technique is used in every product where cost decision is required. Examples of products where detailed costing is required are:

Automobile
Industrial Machines
Mobiles

Averaging technique is used where goods or services require continuous operation or process and products are identical which cannot be segregated. For these products and services process costing method is used. Examples for the products where averaging technique or process costing is used are:

Food processing
Dairy Products
Chemicals

Conversion cost means amount incurred to convert the raw material into finished goods and include direct labour and overhead cost. Inventoriable cost also known as product cost includes cost incurred in manufacturing of the product that is direct material, direct labour and manufacturing overhead.

Thus it can be said that the monthly cost of renting a manufacturing plant is considered as a conversion cost and an Inventoriable cost.

Manufacturing statement and income statement

Tendulkar Manufacturing Company
Manufacturing Account
For the year ended 30 September, 2007
Particular	Amount ($)	Particular	Amount ($)
Direct Material		Closing Stock:
Opening Stock:		Raw Material	16000
Raw Material	110000	Work in Progress	7000
Work in Progress	15000
Purchases:		Cost of Goods Sold	1026000
Raw material	500000
Work in Progress
Carriage Inward	22000
Direct labour	130000
Direct Expenses
Depreciation	9000
Factory Insurance	3000
Manufacturing overhead
Manufacturing Expense	60000
Factory Salary	200000
	1049000		1049000

Tendulkar Manufacturing Company
Manufacturing Account
For the year ended 30 September, 2007
Particular	Amount ($)	Particular	Amount ($)
Direct Material		Closing Stock:
Opening Stock:		Raw Material	16000
Raw Material	110000	Work in Progress	7000
Work in Progress	15000
Purchases:		Cost of Goods Sold	=+B22-D8-D9
Raw material	500000
Work in Progress
Carriage Inward	22000
Direct labour	130000
Direct Expenses
Depreciation	=12000*75%
Factory Insurance	=4000*75%
Manufacturing overhead
Manufacturing Expense	60000
Factory Salary	200000
	=SUM(B9:B21)		=SUM(D8:D21)

Tendulkar Manufacturing Company
Income Statement
For the year ended 30 September, 2007
Particular	Amount ($)	Total

Revenues
Sales	1696000
Other Income	0
Total Income (A)		1696000
Expenses
Cost of goods sold	1035750
Salary	100000
Accrued Salary	700
General expenses	23000
Audit Fee	3000
Advertisement	12000
Light and Power	12000
Cartage Outwards	5000
Insurance	750
Rates	2250
Sales Commission	40000
Tax	50000
Discount	6000
Total operating expenses (B)		1290450
Net Income (A-B)		405550

Tendulkar Manufacturing Company
Income Statement
For the year ended 30 September, 2007
Particular	Amount ($)	Total
Revenues
Sales	=1700000-4000
Other Income	0
Total Income (A)		=SUM(B9:B10)
Expenses
Cost of goods sold	=Sheet1!D11
Salary	100000
Accrued Salary	700
General expenses	23000
Audit Fee	3000
Advertisement	12000
Light and Power	12000
Cartage Outwards	5000
Insurance	=400025%-100025%
Rates	=9000*25%
Sales Commission	40000
Tax	50000
Discount	6000
Total operating expenses (B)		=SUM(B14:B26)
Net Income (A-B)		=+C11-C27

Should overtime payments be treated as direct labour, or as overhead? Explain.

Overtime premium is the amount paid to labour in excess to normal wages for the overtime time done. Overtime premium is included in the manufacturing overhead except where overtime is done on the specific request of the customer to speed up the job; in such case overtime can be charged to direct labour.

Prepare a material control account from the given information and journal entry to record the cost materials purchased during April

The Materials Control account balances were $40 000 on 1 April and $20 000 on 30 April. During April direct materials issued to production were $70 000 and indirect materials consumed were $30 000.

Material control account
For the month of April
Particular	amount ($)	Particular	amount ($)
To balance brought down	40000	By Work in progress (Direct material issued to production)	70000
		By Factory overhead (Indirect material used)	30000
To account payable (Material Purchased) Balancing figure	80000
		By balance carried down	20000
	120000		120000

Material control account
For the month of April
Particular	amount ($)	Particular	amount ($)
To balance brought down	40000	By Work in progress (Direct material issued to production)	70000
		By Factory overhead (Indirect material used)	30000
To account payable (Material Purchased) Balancing figure	=+D6+D7+D9-B6
		By balance carried down	20000
	=SUM(B6:B9)		=SUM(D6:D9)

Journal Entry
Particular	Amount ($)	Amount ($)
Account payable account Dr.	80000
To Material Control Account		80000

Salaries and wages payable to factory employees were $20 000 on 1 March and $8000 on 31 March. Gross salaries and wages paid during March totalled $50 000. March’s direct labour totalled $28 000.
Prepare T-account for Accrued Payroll for March and journal entries for recording salaries and wages earned by factory employees during March

Accrued Payroll Account
For the month of March
Particular	amount ($)	Particular	amount ($)
To salary paid	50000	By balance brought down	20000
		By Wages payable	28000
		By Direct labour payable	10000
To balance carried down	8000
	58000		58000

Accrued Payroll Account
For the month of March
Particular	amount ($)	Particular	amount ($)
To salary paid	50000	By balance brought down	20000
		By Wages payable	28000
		By Direct labour payable	=+B18+B21-D18-D19
To balance carried down	8000
	=SUM(B18:B21)		=SUM(D18:D21)

Journal Entry
Particular	Amount ($)	Amount ($)
Direct labour account Dr.	10000
Salary and wages account Dr.	20000
To Accrued payroll Account		48000

Total hours worked – 48 hours during the pay week ending Friday April 24.

His normal working week consists of 40 hours, of which 35 hours were spent on production while the remaining 5 hours were non-productive idle time.

Smith worked 2 hours overtime at a premium of 50% on Monday April 20.

Smith worked further 6 hours overtime on Wednesday April 22.

It is the policy of the company to pay an overtime premium of 100% after the first 3 hours on any one day. Smith’s normal wage rate is $22 per hour.

Gross salary of Smith
For the month of April
Particulars	Amount ($)
Normal hours worked	880
Overtime done on 21st	66
Overtime done on 22nd	99
Overtime done on 22nd	132
Total Pay	1177

Gross salary of Smith
For the month of April
Particulars	Amount ($)
Normal hours worked	=40*22
Overtime done on 21st	=222150%
Overtime done on 22nd	=322150%
Overtime done on 22nd	=322200%
Total Pay	=SUM(B4:B7)

Amount to be treated as indirect cost
Overtime wages for 21st	=2(2250%)
Idle time	=5*22
Overtime wages for 22nd	=3(2250%)
Overtime wages for 22nd	=2(22100%)
Total indirect cost	=SUM(B12:B15)

Traditional and Activity Based Costing

Refer word document ‘Report on ABC and traditional costing’

Direct Method

Department (Amount in $)
Particulars	P1	P2	S1	S2
Direct material and labour	200000	150000	10000	15000
Indirect Cost	90000	70000	6000	18000
	290000	220000	16000	33000
Department S1 Reallocation	1200	3000	–	–
Department S2 Reallocation	7714.285714	5142.857143	–	–
	298914.2857	228142.8571	16000	33000

Department (Amount in $)
Particulars	P1	P2	S1	S2
Direct material and labour	200000	150000	10000	15000
Indirect Cost	90000	70000	6000	18000
	=SUM(B4:B5)	=SUM(C4:C5)	=SUM(D4:D5)	=SUM(E4:E5)
Department S1 Reallocation	=6000*20/100	=6000*50/100	–	–
Department S2 Reallocation	=18000*30/70	=18000*20/70	–	–
	=SUM(B6:B8)	=SUM(C6:C8)	=SUM(D6:D8)	=SUM(E6:E8)

Department (Amount in $)
Particulars	P1	P2	S1	S2
Direct material and labour	200000	150000	10000	15000
Indirect Cost	90000	70000	6000	18000
	290000	220000	16000	33000
Department S2 Reallocation	3600	9000	5400	-18000
Department S1 Reallocation	4885.714286	3257.142857	-11400	–
	298485.7143	232257.1429	10000	15000

Department (Amount in $)
Particulars	P1	P2	S1	S2
Direct material and labour	200000	150000	10000	15000
Indirect Cost	90000	70000	6000	18000
	=SUM(B16:B17)	=SUM(C16:C17)	=SUM(D16:D17)	=SUM(E16:E17)
Department S2 Reallocation	=18000*20/100	=18000*50/100	=18000*30/100	=-E17
Department S1 Reallocation	=11400*30/70	=11400*20/70	=-(D17+D19)	–
	=SUM(B18:B20)	=SUM(C18:C20)	=SUM(D18:D20)	=SUM(E18:E20)

S1 = 6000 + 20/70 * S2 – Equation 1

S2 = 18000 + 30/100 * S1 – Equation 2

Putting the value of S2 in equation 1

S1 = 6000 + 20/70 * (18000 + 30/100 * S1)

S1 = 6000 + 5142.857 + .0857 S1

S1 = 11142.857 + .0857 S1

0.9143 S1 = 11142.857

S1 = 12187.30942

Putting the value of S1 in Equation 2

S2 = 18000 + 30/100 * 12187.30942

S2 = 21656.19283

Department (Amount in $)
Particulars	P1	P2	S1	S2
Direct material and labour	200000	150000	10000	15000
Indirect Cost	90000	70000	6000	18000
	290000	220000	16000	33000
Department S2 Reallocation	5223.132609	3482.088406	12187.30942	3482.088406
Department S1 Reallocation	4331.238566	10828.09642	6496.857849	21656.19283
	299554.3712	234310.1848	10309.54843	14825.89558

Department (Amount in $)
Particulars	P1	P2	S1	S2
Direct material and labour	200000	150000	10000	15000
Indirect Cost	90000	70000	6000	18000
	=SUM(B62:B63)	=SUM(C62:C63)	=SUM(D62:D63)	=SUM(E62:E63)
Department S2 Reallocation	=+H53	=+H54	=+H45	=+H54
Department S1 Reallocation	=+J52	=+J53	=+J54	=+J50
	=SUM(B64:B66)	=SUM(C64:C66)	=+D64-D65+D66	=+E64+E65-E66

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