Detailed Definition§
Production Cost refers to the total expense incurred in the manufacturing of a product or a cost unit. It encompasses all the expenditures related to the creation of goods or services. This includes both direct costs, which can be traced directly to the product, and indirect costs (manufacturing overheads), which are incurred in the production process but cannot be directly linked to a single product.
Cost Components§
- Direct Costs:
- Raw Materials
- Direct Labor
- Manufacturing Overhead:
- Indirect Materials
- Indirect Labor
- Depreciation on production equipment
- Utilities for the production facility
- Maintenance of production equipment
Examples§
-
Automobile Manufacturing:
- Direct Costs: Costs of steel, rubber, glass (raw materials), and wages paid to assembly line workers.
- Manufacturing Overhead: Depreciation on assembly line equipment and salary of production supervisors.
-
Furniture Production:
- Direct Costs: Costs of lumber, screws, glue (raw materials), and wages paid to carpenters.
- Manufacturing Overhead: Utilities such as electricity for running woodworking machinery, and rent for factory space.
Frequently Asked Questions§
What is the difference between direct costs and indirect costs?§
Direct costs can be directly attributed to a specific product, such as raw materials and direct labor. Indirect costs are not directly traceable to a product, such as utility expenses and supervisory salaries.
How do you calculate the total production cost?§
Total production cost is calculated by adding direct costs (direct materials and direct labor) to the manufacturing overheads.
What is the role of production cost in pricing?§
Production cost plays a critical role in determining the selling price of a product. Companies need to cover their production costs to achieve profitability.
What is Cost of Goods Manufactured (COGM)?§
Cost of Goods Manufactured is the total production cost of goods completed during an accounting period. It includes direct expenses and assigned overhead costs.
Related Terms§
- Direct Cost of Sales: The portion of the production cost that includes raw materials and direct labor expenses directly associated with the manufacturing process.
- Manufacturing Overhead: The indirect costs of production that cannot be directly attributed to a specific product. It includes rent, utilities, and depreciation.
- Manufacturing Account: A financial statement prepared to calculate the manufacturing costs of products produced for a period.
- Cost Unit: A measurement unit used to quantify the cost of production for a product or service.
Online References§
- Investopedia: Production Costs
- Corporate Finance Institute: What is Production Cost?
- Accounting Tools: Production Costs
Suggested Books for Further Studies§
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Managerial Accounting” by Ray H. Garrison, Eric W. Noreen, and Peter C. Brewer
- “Principles of Cost Accounting” by Edward J. Vanderbeck, Maria R. Mitchell
Accounting Basics: “Production Cost” Fundamentals Quiz§
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