Basic Costing Principles and Manufacturing Concerns Presentation

Basic costing principles
and manufacturing
concerns
Cost classification
• Variable Costs
• Costs that varies in direct proportion to change in the level of activity, over a defined period of time. For
example: Every meal sold has a variable component – the ingredients that goes into the meal.
• Fixed Costs
• These costs do not change in the level of activity, over a defined period of time
• Mixed or semi-variable costs
• These type of costs is partially fixed and partly varies with the change in the level of activity, over a
defined period of time. and fixed component to them.
• Step cost
• A fixed cost that increases in steps. The cost is fixed over a specific level of activity and from thereon it
will increase.
Manufacturing entity
• Manufacturing entity is an entity that transforms raw materials into
finished products
Difference between manufacturer and retailer
Categories of inventory
Retailer Manufacturer
Merchandise Raw materials
Work-in-progress
Finished goods
Difference between manufacturer and retailer
(using GP as an example)
Retailer Manufacturer
Sales X Sales X
Cost of sales (X) Cost of sales (X)
Opening inventory x Opening finished goods x
Cost of good purchased x Cost of goods manufactured ** x
Goods available for sales X Goods available for sale X
Closing inventory (x) Closing finished goods (x)
Gross profit X Gross profit X
Manufacturing costs and its three (3) main
categories
• Manufacturing cost is the sum of costs of all resources consumed in the process of
making a product
• Three (3) main categories
 Direct Material cost – Costs of raw material consumed in the manufacturing process that can be
identified in the finished goods.
 Direct Labour cost - Costs incurred in relation to personnel directly involved in the manufacturing
process.
 Manufacturing overheads – Costs incurred in the manufacturing process that cannot be identified or
traced directly to the manufactured product.
• NB: Direct material cost + Direct Labour cost = Prime or Primary costs
Manufacturing overhead
• Manufacturing overheads can be divided into three (3) main categories
 Indirect materials - material items used in the manufacturing process which cannot
be directly and accurately traced to a specific product. Example includes the nails
and screws that were used in the manufacturing of wooden furniture
 Indirect labour – Wages of all employees who do not work on the manufactured
product itself, but who assist in the overall manufacturing operation. Example
includes wages of factory cleaners, security and maintenance personnel
 Other manufacturing overheads – portion of costs, other than indirect materials and
indirect labour. Example includes factory insurance, maintenance and
depreciation of factory equipment (plant and machinery)
Total Costs
Manufacturing costs Non-manufacturing costs
Material costs Labour costs Manufacturing

Selling costs Administrative
overheads
costs
Direct Indirect Direct Indirect

Material cost
• Material cost are the cost price of raw material + delivery cost + storage and
handling costs
 Direct material: Used directly in process of manufacture and can be identified in end
product.
 Indirect material: Necessary but not specifically identified. Can not accurately
measure amount included in finished goods.
 Opening raw material + Purchases + Transport – Closing raw material = cost of
material used in production.
Labour costs
• Labour costs are salaries and wages paid to employees involved in
manufacturing process.
 Direct labour: Salaries and wages paid to employees directly involved in manufacturing
process.
 Indirect labour: Salaries and wages paid to employees not directly involved in
manufacturing process.
Prime costs
• Direct material + Direct labour
Accounting procedures
Physical movement of inventory Accounting for movement
Raw material store Raw material stock account
Labour Overheads
Labour Overheads account account
Factory for Work-in-progress
manufacturing account
Finished goods Finished goods stock

store account
Cost of
Customer sales
Raw material inventory account
Opening balance
Accounts payable Work-in-progress
Bank
Work-in-progress account
Direct costs of raw material

Direct labour costs Inventory (finished goods)
Manufacturing Overheads costs
STATEMENT OF THE COST OF GOODS
MANUFACTURED
• The management of a manufacturing entity uses a statement of cost of
goods manufactured to:
1. Assess the manufacturing efficiency of the entity and
2. To determine the costs of the finished manufactured products
STATEMENT OF THE COST OF GOODS MANUFACTURED FOR THE YEAR ENDED…..
R R
Raw material (Direct Material Cost)
Statement of goods manufactured
Opening balance of raw material
Raw Material purchased
20 000
240 000
Raw Material available for use 260 000
Less Closing balance of raw material (19 000)
Direct Material used in manufacturing 241 000
Direct labour 190 000
Prime costs (DM + DL) (241 000 + 190 000) 431 000
Manufacturing overheads 158 000
Indirect material 5 000
Indirect labour 33 000
Others (e.g. electricity, rent, depreciation) 120 000
Total cost of goods Manufactured 589 000
Add: Work-in-progress opening balance 42 000
Less: Work-in-progress closing balance (40 000)
COST OF FINISHED GOODS MANUFACTURED 591 000 Transfer this figure to SP/L

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Basic costing principles

Manufacturing costs Non-manufacturing costs

Material costs Labour costs Manufacturing

Direct Indirect Direct Indirect

Finished goods Finished goods stock

Direct costs of raw material

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