Skip to main content

Elements of Cost

Costs in manufacturing and service industries are categorized into three primary elements: Material, Labour, and Expenses. These elements are further classified into direct and indirect categories, affecting how they are accounted for in cost calculations.

image

Material

Material refers to the basic substances used in the production of goods. Materials are categorized into direct and indirect materials based on their role and traceability in the production process.

Direct Material

Direct materials are those that directly contribute to the production of a product and are easily identifiable in the finished product. Examples include:

  • Cloth in shirts
  • Paper in books
  • Wood in furniture

Direct materials are traceable to specific goods and are a significant part of the cost of goods manufactured.

Indirect Material

Indirect materials are ancillary to the production of a finished product and cannot be conveniently assigned to specific units of output. Examples include:

  • Printing ink used in stationery
  • Scissors used in cutting cloth for shirts
  • Nails used in shoes or furniture

Indirect materials are part of overhead costs as they support the production process but are not directly traceable to specific products.

Labour

Labour refers to the human effort required to convert materials into finished goods and is categorized into direct and indirect labour based on the nature of work and its traceability to specific products.

Direct Labour

Direct labour includes workers who take an active and direct part in the production process, whose efforts can be directly correlated to specific activities or products. Examples include:

  • Workers operating machinery
  • Assemblers in a manufacturing line
  • Carpenters making furniture

Direct labour costs are directly associated with specific products or services and form a significant part of the total cost of production.

Indirect Labour

Indirect labour involves employees who do not directly participate in the production process, and their costs cannot be identified with individual cost centers. Examples include:

  • Salaries of foremen
  • Wages of maintenance staff
  • Salaries of administrative personnel

Indirect labour costs are part of overheads as they support the production process but are not directly traceable to specific products.

Expenses

Expenses are costs incurred in the production process that are not classified under material or labour. Expenses are also divided into direct and indirect expenses.

Direct Expenses

Direct expenses are those that can be directly, conveniently, and wholly allocated to specific cost centers or cost units. These are sometimes described as chargeable expenses and can include:

  • Cost of hiring special equipment for a job
  • Expenses directly related to a specific project

Indirect Expenses

Indirect expenses encompass all other expenses not classified as direct. These expenses support the overall operations and include:

  • Utility costs
  • Depreciation
  • Administrative expenses

Overheads

Overheads is a term that encompasses the total cost of indirect material, indirect labour, and indirect expenses. Overheads are further categorized into:

  • Factory Overheads: Expenses incurred within the factory for its operation, like rent, power, and maintenance.
  • Office and Administrative Overheads: Expenses related to the management and administration of the business, such as office rent, salaries of administrative staff, and office supplies.
  • Selling and Distribution Overheads: Costs associated with marketing, securing orders, dispatching goods, and customer retention efforts.
Back to top