Topic 19: Cost flow in a manufacturing business

Question 1

What is the formula for Manufacturing cost?

Answer 1

Manufacturing cost = Direct cost OR Prime cost (Direct materials + Direct labour) + Indirect costs (Factory overheads OR Manufacturing overheads)

Question 2

What is Factory/Manufacturing Overheads?

Answer 2

1) Factory overhead consists of all manufacturing costs that are NOT direct materials or direct labour.

These refer to expenses which occur INSIDE the factory where the production is carried out but which CANNOT BE SEPARATELY OR READILY TRACED TO THE UNITS BEING MANUFACTURED (finished goods)

2) FOH do not vary with output

3) FOH excludes selling and distribution expenses, general and administrative expenses and financial expenses. These expenses excluded are non-manufacturing costs and are recorded as expenses to be deducted from the gross profit on the income statement when incurred.

Question 3

What are Direct costs (or Prime costs) ?

Answer 3

1) Include all costs which are EASILY TRACEABLE to the item being manufactured
2) Vary with the units of output, i.e more output -> more direct costs
3) It comprises of Direct materials and Direct labour

Question 4

What are Direct materials?

Answer 4

1) These are tangible components of a finished product
2) Direct material costs are COSTS OF RAW MATERIALS TRACEABLE TO AN ITEM being manufactured
3) Note: costs incurred in the purchase of raw materials e.g duties and freight must be added to the cost price of the raw materials

Question 5

What are Conversion costs?

Answer 5

Conversion costs = Direct labour + Factory overheads

Question 6

What is Total production cost?

Answer 6

Total production cost = Direct materials + Direct wages + Manufacturing overheads