A manufacturing business purchases raw materials and uses them in the production process to generate an end product that can be sold to the customers. How does such a business keep its books of accounts? How does the company determine the value of inventory and the price of the end product? The answer to these questions is cost accounting.
Cost accounting is a branch of accounting that deals with calculation of costs per unit of product, management of that cost, and control of the cost per unit. It is a valuable tool that you can use to minimize the costs incurred in your production process and determine the price of a product that is likely to generate maximum revenue for your business. Here are the concepts of cost accounting that you should know.
Classification of costs
In cost accounting, the manufacturing costs are classified into direct material costs, direct labor costs, manufacturing overheads, and non-manufacturing costs. Direct materials are the raw materials that you use in the production process and are an integral part of the end product. For example, if you own a car assembling business, a steering wheel can be classified as a direct material.
Direct labor costs are the cost of labor that can be directly traced to individual units of the end product. For example, wages paid to a worker in car assembling business. Manufacturing overheads are the costs that you can’t easily trace them to a particular unit of the end product. Examples of manufacturing overheads include indirect materials such as cleaning supplies used in the automobile business and the indirect labor such as security guards.
Non-manufacturing costs include the selling costs and administrative costs. The selling costs include the costs incurred when securing your clients’ orders and delivering the product. On the other hand, administrative costs include the costs associated with supervision of the production process and other administrative activities.
Recording the costs in your business books
The product cost comprises direct materials, direct labor, and manufacturing overheads. The product cost figure is the inventory for your business, and it should appear in your business balance sheet. When this inventory is sold, you should recognize the sale in your business income statement. All selling and administrative costs are expenses and should be reported in the income statement.
Understanding the basic classification of costs for a manufacturing firm is the first step in understanding cost accounting. Watch out for our next posts on cost accounting. “Nah, that is too much”? Engage our accounting services in Singapore today and let us crunch the number for you instead.