Unlike a trading business, a manufacturing business buys products to use them as materials in making a new product. Thus, there is a transformation of the purchased products. A manufacturing business combines raw materials, labor, and overhead costs in its production process. The manufactured goods will be sold to customers. It is important to distinguish direct and indirect cost in a manufacturing business.
DIRECT COSTS (PRIME COST)
We can trace costs that can be full to a cost unit. A direct cost can be attributed in its entirety to the cost of an item that is being produced.
Direct material costs
Direct materials are all materials that become part of the cost unit. The direct materials are all materials that can be attributed directly in full to a cost unit. They are used directly in the manufacture of a product or in providing a service. For example, sugarcane used in producing sugar is a direct material cost.
Direct labour costs
Direct labor is labor time that can be attributed directly in full to a cost unit. For example, wages of labor working in the assembly of automobile manufacturing are direct labor costs.
Direct expenses
Direct expenses are expenses that can be attributed directly in full to a cost unit. All direct expenses are expenses that have been incurred in full as a direct consequence of making a unit of product. For example, We pay a royalty to the product designer/patent holder for each unit.
Prime Cost
The prime cost of a cost unit is the sum of all of the direct costs of making that unit.
Prime cost = direct material cost + direct labor cost + direct expenses
INDIRECT COSTS
An indirect cost (overhead cost) is any cost that is not a direct cost. The indirect costs (overheads) cannot be attributed directly and in full to a cost unit.
Indirect materials cost
Indirect materials are any materials that are used or consumed that cannot be attributed in full to the item being costed. The indirect materials in production include cleaning materials and any materials used by production departments or staff who are not engaged directly in making a product.
Indirect labor costs
All Indirect labor costs consist mainly of the cost of indirect labor employees. Indirect labor employees are individuals who do not work directly on the items that are produced or the services that are provided.
Some factory workers do not work directly in the production of cost units but are necessary so that production takes place. In a manufacturing environment, indirect labor employees include staff in the stores and materials handling department (for example, forklift truck drivers), supervisors, and repairs and maintenance engineers.
Indirect expense
Many costs incurred cannot be directly linked to cost units. For example, We can not attribute the rental costs for a factory and the costs of gas and electricity consumption for a factory in full to any particular production units. They are indirect production costs (production overheads).
FULL COST OF UNIT Direct and Indirect Cost
| The full cost of a unit of product (or the full cost of a unit of service) is a cost that includes both direct costs and overheads. | |
| Direct materials cost | XX |
| The direct labour cost | XX |
| All Direct expenses | XX |
| Prime cost | XX |
| Manufacturing (or production) overhead i.e. indirect production costs | XX |
| Full production cost | XX |
| Non-production costs | |
| Administration overhead | XX |
| Selling and distribution overhead | XX |
| The full cost of the unit | XX |
| Profit margin | XX |
| Selling price | XX |
Frequently Asked Questions
What are examples of direct and indirect costs?
Direct labor, direct materials, commissions, piece rate pay, and manufacturing supplies are a few examples of direct costs. Payroll for production supervision, expenses for quality control, insurance, and depreciation are a few indirect costs.
What is a direct cost for example?
A price that may be directly linked to the creation of particular goods or services is called a direct cost. The cost item, which could be a department, product, or service, can be linked to a direct cost.
Is the cost of fuel direct or indirect?
You must debit Diesel and fuel as direct expenses to the manufacturing account in the direct cost portion.
What is a prime cost and conversion cost?
Conversion costs are incurred during the process of transforming raw materials into a product, whereas prime costs are directly associated with the creation of completed goods. Prime cost includes Direct labor and material costs.