There are broadly three elements of cost – (1) material, (2) labour and (3) expenses.:
The substance from which the product is made is known as material. It may be in a raw state-raw material, e.g., timber for furniture and leather for shoe, etc. It may j also be in manufactured state-components, e.g., battery for car, speaker for radio, etc, Materials can be direct and indirect.
Direct Material: All materials which become an integral part of the finished j product, the cost of which are directly and completely assigned to the specific physical units and charged to the prime cost, are known as direct material. The following are some of the materials that fall under this category:
(a) Materials which are specifically purchased; acquired or produced for a particular job, order or process.
(b) Primary packing material (e.g. carton, wrapping, cardboard, etc.)
(c) Materials passing from one process to another as inputs.
In order to calculate the cost of material, expenses such as import duties, dock charges, transport cost of materials are added to the invoice price.
Material considered direct at one time may be indirect on other occasion. Nail used in manufacturing wooden box is treated as direct material, but treated as indirect material when used to repair the factory building.
Indirect Material: All materials, which cannot be conveniently assigned to specific physical units, are termed as ‘indirect material’. Such commodities do not form part of the finished products. Consumable stores, lubrication oil, stationery and spare parts for the machinery are termed as indirect materials.
Human efforts used for conversion of materials into finished products or doing various jobs in the business are known as labour. Payment made towards the labour is called labour cost. It can also be direct and indirect.
Direct Labour: Direct labour is all labour expended and directly involved in altering the condition, composition or construction of the product. The wages paid to skilled and unskilled workers for manual work or mechanical work for operating machinery, which can be specifically allocated to a particular unit of production, is known as direct wages or direct labour cost. Hence, ‘direct wage’ may be defined as the measure of direct labour in terms of money. It is specifically and conveniently traceable to the specific products Wages paid to the goldsmith for making gold ornament is an example of direct labour.
Indirect Labour: Labour employed to perform work incidental to production of goods or those engaged for office work, selling and distribution activities are known as ‘indirect labour’. The wages paid to such workers are known as ‘indirect wages’ or indirect labour cost.
Example: Salary paid to the driver of the delivery van used for distribution of the product.
All expenditures other than material and labour incurred for manufacturing a product or rendering service are termed as ‘expenses’. Expenses may be direct or indirect.
Direct Expenses: Expenses which are specifically incurred and can be directly and wholly allocated to a particular product, job or service are termed as ‘direct expenses’. Examples of such expense are: hire charges of special machinery hired for the fob, carriage inward, royalty, cost of special and specific drawings, etc. These are also known as ‘chargeable expenses’.
Indirect Expenses: All expenses excluding indirect material and indirect labour, which cannot be directly and wholly attributed to a particular product, job or service, are termed as ‘indirect expenses’. Some examples of such expenses are: repairs to machinery, insurance, lighting and rent of the buildings.
The elements of cost may be shown by means of a chart as follows: