PRODUCT COSTING ✔

Product costing   

The term "product cost" refers to any expenses incurred by a business in producing its own goods 

or providing services to consumers. These expenses are recorded in the business' financial statements 

for the time period during which they are included in the price of the products it sells.

EXAMPLES :

1. Direct material (DM)
2. Direct labor (DL)
3. Factory overheads (FOH)

In order to produce a finished commodity (or service) that is ready for sale from raw materials,

 it is necessary to pay for the cost of raw material, labour, and factory overheads.

According to GAAP and IFRS, product expenses must be capitalized as inventory in the balance 

sheet and should not be expensed in the profit and loss statements because such costs are paid for 

with benefits and value that will be realized in subsequent periods.

Direct Material cost :

Direct costs in cost accounting refer to the raw materials that are converted into completed goods by 

using direct labour and factory overheads. Raw materials that are simple to identify and quantify are 

referred to as direct materials. For instance, to build a car, an automobile manufacturing business 

normally needs metal and plastic. 

It is simple to count or keep track of how many of these resources there are. However, lubricants

 like oils and grease are also needed when making cars. However, it can be very challenging or

 pointless to identify the low value of grease used in a specific vehicle; for this 

reason, indirect costs are used.

Direct Labour cost :

Workers who work directly in the production or manufacturing of finished goods from raw 

materials are known as direct labourers. The salary, wages, and perks (such as insurance) given to

 these labour forces in exchange for their services comprise the direct labour costs. Direct labourers

 include or instance, those who work on an assembly line at an automobile factory to weld metal, fix 

screws, apply grease and put parts of metal and plastic together to make a car. 

However, an employee must be closely related to a given job in order to be categorised as direct labour. 

For instance, a secretary at a sizable auto manufacturer must take on various tasks as needed. Thus, it 

becomes challenging to measure.

Factory Overheads :

The indirect expense related to manufacturing a finished product that cannot be directly traced is the 

factory or manufacturing overheads. In other words, overheads are that costs that is neither direct 

material nor direct labor. That is why overheads are indirect costs that include indirect labor and 

material costs.

Indirect Material : The materials used in the manufacturing process cannot be traced directly as 

raw materials are indirect materials. 

E.g., grease, oil, welding rods, glue, tape, cleaning supplies, etc., are all indirect materials. It is difficult 

and not cost-effective to determine the exact expense of indirect materials applied to a single unit of a 

product.

Indirect Labor – The workers or employees required for the smooth functioning of the production 

process but do not get directly involved in creating a finished product are indirect materials. 

E.g., quality assurance teams, security guards, supervisors, etc., in the manufacturing premise are 

classified as the indirect labour force. The associated costs in their salaries, wages and other benefits 

are considered indirect labor costs.

Other Overheads – The factory overheads that fall under the above two categories of factory 

overheads can be classified as other factory overheads. E.g., electricity expenses cannot be 

classified as material or labor. Similarly, costs like factory and equipment depreciation, insurance 

costs, property taxes on factory premises, factory rent or lease, the cost to utilities, etc.

FORMULA :

1. Product Cost Formula = Direct Labor + Direct Material + Factory Overheads

2. Factory OH = Indirect Labor + Indirect Material + Other Factory OH

3. Product Cost per Unit Formula = (Total Product Cost ) / Number of Units Produced.

Examples of Product Cost :

A direct Material Purchase Budget is required to create a product. The budget is required to 

calculate the amount of raw material that needs to be purchased for the production process and 

estimate the related costs.

Let’s say Raymond’s Pvt. Ltd, a small shirt manufacturing company, requires fabric, thread, 

and buttons. Consider the direct raw material to be just fabric, while the requirements of the 

other two materials cannot be directly tracked and are hence considered indirect.

The company targets to produce the following number of shirts in each quarter of the year. Data 

collected from the production budget

EXAMPLES OF PRODUCT COST :

Raymond management collects the following details to create its direct raw material budget:

The cost of fabric is $80 per kilo. The production department requires 500 grams (or 0.5 kg) of fabric 

to manufacture a single shirt.

Management decides to store at least 10% of fabric for the following-quarter production requirements.

At the beginning of the year (January-1), the opening value of the stock of fabric was 210 kilos. 

Assume the desired value of ending inventory is 250 kilos at the end of the year (quarter 4)

Accounting equations : 

Total Raw Material = Raw Material Required for Production + Ending Raw Material Inventory.

Raw material to be Purchased = Total Raw Material Required – Beginning Raw Material Inventory.

CONCLUSION  :

The Product cost budget determines the overall expenses incurred by an entity to create a product on a

 periodical basis. The management can further calculate the cost per unit by dividing the estimated 

units produced as per the production budget.

By estimating the per-unit cost, the entity can set an appropriate sales price and avoid under-pricing

 or over-pricing its products. Both product under-pricing and overpricing bring losses to the entity.

Under-pricing means the entity is charging less than the product cost -> Losses.

Overpricing leads customers to look for substitutes ->, less demand, -> Losses.

REFERENCES :

1. Chiselglosarry.com
2. Wallstreetmojo.com
3. blogssap.com

AUTHORS :

1. Bhosle Dnyaneshwar 
2. omkar Gholap 
3. waghmode Kiran