Elements of Cost & Overheads


Costs can be classified based on the following attributes:

By Nature

In this type, material, labor and overheads are three costs, which can be further sub-divided into raw materials, consumables, packing materials, and spare parts etc.

By Degree of Traceability of the Product

Direct and indirect expenses are main types of costs come under it. Direct expenses may directly attributable to a particular product. Leather in shoe manufacturing is a direct expenses and salaries, rent of building etc. come under indirect expenses.

By Controllability

In this classification, two types of costs fall:
  • Controllable - These are controlled by management like material labour and direct expenses.
  • Uncontrollable - They are not influenced by management or any group of people. They include rent of a building, salaries, and other indirect expenses.

By Relationship with Accounting Period

Classifications are measured by the period of use and benefit. The capital expenditure and revenue expenditure are classified under it. Revenue expenses relate to current accounting period. Capital expenditures are the benefits beyond accounting period. Fixed assets come under category of capital expenditure and maintenance of assets comes under revenue expenditure category.

By Association with the Product

There are two categories under this classification:
  • Product cost - Product cost is identifiable in any product. It includes direct material, direct labor and direct overheads. Up to sale, these products are shown and valued as inventory and they form a part of balance sheet. Any profitability is reflected only when these products are sold. The Costs of these products are transferred to costs of goods sold account.
  • Time/Period base cost - Selling expenditure and Administrative expenditure, both are time or period based expenditures. For example, rent of a building, salaries to employees are related to period only. Profitability and costs are depends on both, product cost and time/period cost.

By Functions

Under this category, the cost is divided by its function as follows:
  • Production Cost - It represents the total manufacturing or production cost.
  • Commercial cost - It includes operational expenses of the business and may be sub-divided into administration cost, and selling and distribution cost.

By Change in Activity or Volume

Under this category, the cost is divided as fixed, variable, and semi-variable costs:
  • Fixed cost - It mainly relates to time or period. It remains unchanged irrespective of volume of production like factory rent, insurance, etc. The cost per unit fluctuates according to the production. The cost per unit decreases if production increases and cost per unit increases if the production decreases. That is, the cost per unit is inversely proportional to the production. For example, if the factory rent is Rs 25,000 per month and the number of units produced in that month is 25,000, then the cost of rent per unit will be Rs 1 per unit. In case the production increases to 50,000 units, then the cost of rent per unit will be Rs 0.50 per unit.
  • Variable cost - Variable cost directly associates with unit. It increases or decreases according to the volume of production. Direct material and direct labor are the most common examples of variable cost. It means the variable cost per unit remains constant irrespective of production of units.
  • Semi-variable cost - A specific portion of these costs remains fixed and the balance portion is variable, depending on their use. For example, if the minimum electricity bill per month is Rs 5,000 for 1000 units and excess consumption, if any, is charged @ Rs 7.50 per unit. In this case, fixed electricity cost is Rs 5,000 and the total cost depends on the consumption of units in excess of 1000 units. Therefore, the cost per unit up to a certain level changes according to the volume of production, and after that, the cost per unit remains constant @ Rs 7.50 per unit.
The following chart shows the various elements of cost and how they are classified.


Direct or Indirect Materials

The materials directly contributed to a product and those easily identifiable in the finished product are called direct materials. For example, paper in books, wood in furniture, plastic in water tank, and leather in shoes are direct materials. They are also known as high-value items. Other lower cost items or supporting material used in the production of any finished product are called indirect material. For example, nails in shoes or furniture.

Direct Labor

Any wages paid to workers or a group of workers which may directly co-relate to any specific activity of production, supervision, maintenance, transportation of material, or product, and directly associate in conversion of raw material into finished goods are called direct labor. Wages paid to trainee or apprentices does not comes under category of direct labor as they have no significant value.

Overheads

Indirect expenses are called overheads, which include material and labor. Overheads are classified as:
  • Production or manufacturing overheads
  • Administrative expenses
  • Selling Expenses
  • Distribution expenses
  • Research and development expenses


Explain the importance of cost sheet?How is it prepared?

Cost sheet is a statement, which shows various components of total cost of a product. It classifies and analyses the components of cost of a product. Previous periods data is given in the cost sheet for comparative study. It is a statement which shows per unit cost in addition to Total Cost. Selling price is ascertained with the help of cost sheet. The details of total cost presented in the form of a statement is termed as Cost sheet. Cost sheet is prepared on the basis of : 1. Historical Cost 2. Estimated Cost

Historical Cost 
Historical Cost sheet is prepared on the basis of actual cost incurred. A statement of cost prepared after incurring the actual cost is called Historical Cost Sheet.

 Estimated Cost 
Estimated cost sheet is prepared on the basis of estimated cost. The statement prepared before the commencement of production is called estimated cost sheet. Such cost sheet is useful in quoting the tender price of a job or a contract. Importance of Cost Sheet The importance of cost sheet is as follows:

 Cost ascertainment 
The main objective of the cost sheet is to ascertain the cost of a product. Cost sheet helps in ascertainment of cost for the purpose of determining cost after they are incurred. It also helps to ascertain the actual cost or estimated cost of a Job. 

 Fixation of selling price
To fix the selling price of a product or service, it is essential to prepare the cost sheet. It helps in fixing selling price of a product or service by providing detailed information of the cost. 

Help in cost control 
For controlling the cost of a product it is necessary for every manufacturing unit to prepare a cost sheet. Estimated cost sheet helps in the control of material cost, labour cost and overheads cost at every point of production. 

 Facilitates managerial decisions It helps in taking important decisions by the management such as: whether to produce or buy a component, what prices of goods are to be quoted in the tender, whether to retain or replace an existing machine etc.
Preparation of Cost Sheet

A cost sheet is prepared to know the outcome and breakup of costs for a particular accounting period. Columnar form is most popular. Although cost sheets are prepared as per the requirements of the management, the information to be incorporated in a cost sheet should comprise of cost per unit and the total cost for the current period along with the cost per unit and the total cost of preceding period. Data of financial statement is used for preparation of cost sheet. Therefore, reconciliation of cost sheet and financial statement should be done on a regular interval.


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