Factory Cost Definition
Factory Costs are the expenses that are incurred by the business to manufacture goods that are intended to be sold to the customers in the normal course of business and includes all cost linked to production like the direct material cost, direct labor cost and other manufacturing overheads.
Factory Cost Categories
These costs are categorized into three different costs: they are:
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For eg:
Source: Factory Cost (wallstreetmojo.com)
#1 – Direct Material
These costs are associated with the procurement of materials required for the production of goods. For example, if a company is in the business of car manufacturing then the purchase of plastic, iron, etc. is the direct material costDirect Material CostDirect Material Cost is the total cost incurred by the company in purchasing the raw material along with the cost of other components including packaging, freight and storage costs, taxes, etc. that are related directly to the manufacturing and production of various products of the company.read more, but if the plastic is purchased for any other purpose and not for the use in manufacturing, then the same will not be considered as direct material cost.
#2 – Direct Labour
These costs include the wages and other benefits paid to the factory staff or to the employees that are involved in the manufacturing of goods. For example, workers salary who works in the factory to manufacture goods is the direct labor costDirect Labor CostDirect labor costs refer to the total cost incurred by the company for paying the wages and other benefits to its employees against the task performed by them, which are straight away related to the manufacturing of the products or provision of the services.read more, but the office staff salary is the administrative cost.
#3 – Manufacturing Overheads
These costs include all the costs that are directly linked to the production of goods except direct material and direct labor costs. The example of the same is the materials that are not directly allocated to the product but are used in products such as oil, glue, tape, power & fuel, etc. and also the wages paid to the employee is manufacturing overheadManufacturing OverheadManufacturing Overhead is the total of all the indirect costs involved in manufacturing a product like Property Tax on the production premise, Remunerations of maintenance personnel, Rent of the manufacturing building, etc. read more who are not working directly to manufacture goods but they are also present in the factory for supervisions and other things like a security guard, supervision employee, etc.
How to Calculate Factory Cost?
Traditionally these costs are divided into three different categories, which include direct material costs, direct labor cost, and manufacturing overheads. Now, in order to calculate this cost, the following steps can be used:
Step 1: Firstly, determine the total value of the direct material costs required for the manufacturing of the goods. These are basically the costs of the material which are associated directly with the manufacturing of the goods of the company. The formula for calculating the direct materialDirect MaterialDirect materials are raw materials that are directly used in the manufacturing process of a company's goods and/or services and are an essential component of the finished goods manufactured.read more cost is:
Direct Material Costs = Beginning Direct Materials + Direct Materials Purchases – Ending Direct Materials.
Step 2: Then, determine the total value of the direct labor costs required for the manufacturing of the goods. These are basically the costs of the labor which are associated directly with the manufacturing of the goods of the company. The formula for calculating the direct labor cost is:
Direct Labor Costs = Number of Direct Labor Hours * Hourly Rate of Direct Labor
Step 3: After that, determine the total value of the manufacturing overhead required for the manufacturing of the goods. These are basically the costs incurredCosts IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more to run the factory but are not associated with a specific inventory unit. The manufacturing costs generally include Factory rent expenses, factory utility bills, Production supplies, Supervisor salaries, etc. So, in order to determine manufacturing overhead, all these costs are added together.
Step 4: Finally, the factory cost will be determined by adding the total value of the direct material costs, the total value of the direct labor costs, and the total value of the manufacturing overhead. So, the formula would be:
Factory Cost = Total Value of Direct Material Costs + Total Value of Direct Labor Costs + Total Value of Manufacturing Overhead
Example
Let’s take the example of a company named Cloud incorporation, which deals with the manufacturing of clothes. The following are the details of the transactions by the company during the financial year 2019-20:
Solution:
Calculation of Direct Material Cost will be –
- Direct Material Cost = $550000 + $1000000 – $450000 = $1100000
Calculation of Direct Labor Cost will be –
- Direct Labor Cost = $20 * $100000 = $2000000
Calculation of Manufacturing Cost will be –
- Manufacturing Cost = $100000 + $50000 + $240000 = $390000
Calculation of Factory Cost will be –
The Factory utility bills, Production supplies and Factory Rent paid are the expense that is directly linked to the production, so it is included in factory cost. Moreover, the sales & marketing cost is the part of selling & distribution overhead, and research & development expenses are the part of research & development cost, so they are also not included in this cost.
Advantages
- These costs are the most important cost for the production of goods that are to be sold in the market to generate revenue. Without incurring these costs, the business of any person cannot survive.
- These costs provide benefits of taxation as all the factory costs are deductible from the revenues to get the income on which the tax is to be paid.
- The manufacturing overheads that are included in these costs are generally fixed in nature. In case the production is on a large scale, the manufacturing overheads remain the same. Therefore, it results in cost-cutting because by incurring the same manufacturing cost, more production of goods can be done.
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