Elements of Costing

Elements of Costing: Material Cost

Materials are products that are further processed or consumed during the process of manufacturing goods. Stores is a very commonly used synonym of materials, but it has a wider scope as compared to materials. Stores not only includes raw materials but also include other items such as spare parts, maintenance tools, consumables, etc. Materials not only refers to raw material but also include work-in-progress, finished goods and scrap too.

Material cost comprises a major chunk of the total cost. The percentage may differ on the basis of industries. Some service-oriented industries also require a stock of inventories. A continuous and timely supply of material is very necessary to maintain continuity in production and for such other reasons proper control of material cost is very necessary.

Objectives of Material Control

• Continuous material supply for hurdle-free flow of production.
• Determining the right quantity to purchase.
• Reduction of wastage.
• Maintaining coordination between purchase and other departments.
• Proper storing of materials.

Methods of Maintaining Materials

1. Perpetual Inventory System
2. Periodical Stock Verification
3. ABC Analysis
4. VED Analysis
5. FSN Analysis
6. Just-In-Time

Methods of Pricing Materials

Cost Price Method

(a) FIFO

(b) LIFO

(c) Safety Stock Method

Specific Price Method

(a) Average Price Method

(b) Simple Average Price Method

(c) Weighted Average Price Method

(d) Moving Simple Average Method

(e) Moving Weighted Average Method

Market Price Methods

(a) Replacement Method

(b) Realizable Price Method

Notional Price Methods

(a) Standard Price

(b) Inflated Price

Elements of Costing: Labor Cost

Labor cost can also be termed as employee cost. It involves a human aspect in it. The salaries, wages, payrolls, incentives or bonus paid to the employees for their contribution in manufacturing goods or providing services or for any other ancillary services, is the labor cost of that entity. This could be direct as well indirect in nature. For example, wages paid to the labor who performs any function in any stage of the manufacturing process is direct labor cost, however, the salary paid to the gatekeeper or the guard of the warehouse is an example of indirect cost.

A proper study of labor is required to compute its cost and to control the same. If the productivity is low, it will lead to high labor costs and vice-versa.

Objectives of Labor Cost Control

• Time and motion study.
• Controlling idle time and over time.
• Calculation of bonus and incentives.
• Controlling labor turnover.
• Evaluation of job.

Methods of Calculating Wages & Payment

Rates on the basis of time

(a) At ordinary levels

(b) At higher levels

(c) GTRS (Graduated Time Rate)

Rates on the basis of units manufactured

(a) Straight Piece Rate

(b) Piece Rate plus Guaranteed Daily Rates

(c) Differential Piece Rates

Bonus Systems

(a) Individual Rewards for Direct Workers

(b) Group Reward to Direct Workers

(c) Reward to Indirect Workers

Indirect Incentives in terms of Money

(a) Share in Profits

(b) Co-partnerships

Elements of Costing: Direct Expenses

Direct expenses include all the expenses apart from material and labor which are directly associated with the goods manufactured. For instance, machinery, that is used only in the production of a particular product then its depreciation will be the direct expense of that particular product.

If the organization is departmentalized, more percentage of the expenses will be treated as direct as they could be directly attributed to the specific products. Any subsidy or incentive or grant received by the entity is deducted from these direct expenses.

Elements of Costing: Overheads

Overheads are expenses that cannot be associated with specific products. These are also termed indirect costs. It is a sum of all indirect costs. Rent, taxes, maintenance, administration expense, selling and distribution charges are some instances of overhead costs.

As these expenses cannot be directly linked with the products, it becomes important to do a proper accounting of such expenses. Overheads are absorbed in product units on a different bases. Process for overhead accounting:

1. Collecting and classifying of overhead
2. Allocation, apportionment and reapportionment of overhead
3. Absorption of overhead

Therefore, overhead absorption is the ultimate aim for accounting for overhead.

Collection & Classification

Overheads incurred can be collected from various sources such as cash books, subsidiary books, payroll sheets, timesheets, stores issue notes, purchase vouchers, and other records and registers.

After considering and collecting all the overheads, these are required to be classified into different groups based on their similarities. Classification is made on the following basis: –

1. Based on Elements – Indirect Material, Indirect Labor and Indirect Expenses.
2. Based on Function of Organization – Manufacturing Overhead, Administrative Overhead, R&D Overhead, Selling and Distribution Overhead.
3. Based on Behavior – Fixed Overhead, Variable Overhead and Semi-variable Overhead.

Allocation, Apportionment & Re-apportionment

Allocation means the distribution of overheads on a logical basis. Allocation of overheads works better when the organization is properly departmentalized. Hence, allocation is a process of identifying the department to which the expense is related.

Apportionment refers to allotting expenses in different proportions. Apportionment comes into the role when the allocation of overhead is not possible. A few examples of apportioning overheads are:

1. Rent – floor space of every department
2. Lighting – number of light points of every department
3. Telephones – number of extensions in each department

Absorption of Overhead

Absorption means reporting overheads in cost records on an approximate basis by calculating a predetermined overhead at regular or average or maximum capacity.

Computing rates of overhead:

Overhead Rate = Total Overhead / Number of units of the Base

Methods of determining overhead rates:

• Actual Overhead Rate:

Actual overheads in the month / Quantity or worth of the base in that month

• Pre-determined Overhead Rate:

Budgeted overhead cost for the year / Budgeted Base for the year

• Single Overhead Rate:

Overhead expenses for factory / Total amount of the base

• Multiple Rates:

Overhead expense assigned to each item or department / Commensurable Base

• Production Unit Method
• Percentage of Direct Wages
• Percentage of Direct Material Cost
• Percentage of Prime Cost
• Machine Hour Rate

Conclusion

Cost is simply divided into three parts, that is, material, labor, and expenses. A further division of these costs is made on the basis of their direct or indirect nature. The sum of all the costs directly attributed to a product is also known by the name of Prime Cost. And all the indirect costs form a part of overheads.