Costs may be classified as manufacturing costs and non-manufacturing costs. This classification is usually used by manufacturing companies.
Manufacturing costs can be further divided into the following categories:
- Direct materials
- Direct labor
- Manufacturing overhead
The above three categories of manufacturing costs are briefly explained below:
Materials that become an integral part of the finished product and that can be easily traced to it are called direct materials. For example wood is a direct material for the manufacturers of furniture. Lime stone is direct material for the manufacturers of cement. Direct materials usually consists of a significant portion of total manufacturing cost. Direct material is sometime called raw material.
The finished product of a company may become raw material of another company. For example, cement is a finished product for manufacturers of cement and raw materials for companies involved in construction business.
The labor cost that can be physically and conveniently traced to a unit of finished product is called direct labor cost or touch labor cost. Examples of direct labor cost include labor cost of machine operators and painters in a manufacturing company. Like direct materials, it comprises of a significant portion of total manufacturing cost.
The sum of direct materials cost and direct labor cost is known as prime cost.
Formula of prime cost:
Prime cost = Direct materials cost + Direct labor cost
Manufacturing overhead cost:
Manufacturing costs other than direct materials and direct labor are categorized as manufacturing overhead cost (also known as factory overhead costs). It usually includes indirect materials, indirect labor, salary of supervisor, lighting, heat and insurance cost of factory etc. Usually, manufacturing overhead costs cannot be easily traced to individual units of finished products.
The sum of direct labor cost and manufacturing overhead cost is known as conversion cost.
Formula of conversion cost:
Conversion cost = Direct labor cost + Manufacturing overhead cost
The sum of direct materials cost, direct labor cost and manufacturing overhead cost is known as manufacturing cost.
Formula of manufacturing cost:
Manufacturing cost = Direct materials cost + Direct labor cost + Manufacturing overhead cost
Non-manufacturing costs are further divided into the following categories:
- Marketing and selling costs
- Administrative costs
Examples of marketing and selling costs include advertising costs, order taking costs and salaries of sales persons etc. Examples of administrative costs include salaries of executives, accounting costs, and general administration costs etc.