Manufacturing Cost: A Basic Accounting Procedure

Manufacturing Costs

A manufacturing business, first of all, must separate between its manufacturing costs and non-
manufacturing costs. Manufacturing costs are the costs of production that are included in the
determination of product cost. Non-manufacturing costs include marketing expenses and the
general and administration expenses of the business, which are referred to as “period costs”.

Manufacturing costs consist of four basic types:

1. Raw materials: What a manufacturer buys from other companies to use in the production
of its own products. For example, General Motors buys tires from Goodyear (or other tire
manufacturers) that become part of GM’s cars.
2. Direct labor: Compensation of employees who work on the production line.
3. Variable overhead cost: Indirect production costs that increase or decrease as the quantity
produced increases or decreases. An example is the cost of electricity that runs a company’s
production machines: If the business increases or decreases the use of those machines, the
electricity cost increases or decreases accordingly.
4. Fixed overhead cost: Indirect production costs that do not increase or decrease as the
quantity produced increases or decreases. These fixed costs remain the same over a fairly
broad range of production output levels.

Fixed manufacturing costs include:

 Salaries for certain production employees who don’t work directly on the production line,
such as; vice presidents, production managers, safety inspectors, security guards,
accountants, and shipping and receiving workers.
 Depreciation of production buildings, equipment, and other manufacturing fixed assets.
 Occupancy costs, such as building insurance, property taxes, and heating and lighting
charges.

Product Costs

Product cost is the sum of four separate cost components — raw materials, direct labor, variable
manufacturing overhead, and fixed manufacturing overhead. All four of the component costs must
be correct to end up with the correct product cost.

Period costs

Costs that are charged to expense when they’re recorded are known as “period costs“. Marketing
costs (such as advertising, sales personnel, or delivery of products to customers) are period costs.
These selling costs are recorded as expenses in the period the costs are incurred. General and
administrative costs (such as legal and accounting, compensation of officers, or information and
data processing) are also period costs.

NOTE: Period costs do not pass through an inventory account.

 PRODUCTION COST COMPONENTS

Absorption Costing Variable Costing

Direct Materials Direct Materials
+ Direct Labor + Direct Labor
+Variable FOH +Variable FOH
+Fixed FOH -
Product Cost Product Cost

ABSORPTION COSTING OR FULL COSTING

- A product costing method that includes all the manufacturing costs (direct materials,
direct labor, and both the variable and fixed factory overhead) in the cost of a unit of
product.
- Under the absorption costing method, fixed factory overhead is treated as a product
cost.

VARIABLE COSTING
- A product costing method that includes only the variable manufacturing costs (direct
materials, direct labor and variable overhead) in the cost of a unit of product.
- Under the variable costing method, fixed factory overhead treated as a period cost.