Elements of Cost

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What is Cost?

In the business sector and accounting department, cost is the monetary value that a company needs to spend in order to produce something. Cost means the amount of money which a company spends on the creation or production of the goods or services. 

Also, to understand cost, we need to check from a seller’s point of view, cost is that amount of money that is spent to produce a good or a product. While, from a buyer’s point of view the cost of a product is also known as the price of the product. This is the amount that the seller charges for buying the particular product, and it includes both the production cost (borne by the seller) and the mark-up price (for the profit of the seller), which is added by the seller in order to make a profit.

In accounting terminology, the term cost refers to the monetary value of expenditures engaged with the production of goods. In the further section we will know more about the elements of cost.

 

Elements of Cost Accounting

In Accounting, a cost is composed of three elements – 

  • Material

  • Labour 

  • Expenses

The above three elements can either be direct and indirect cost.

Thus, to understand the elements of cost we need to learn them vividly.

  • Direct Materials:

As, there will be only one product and the process of manufacture is simple, the raw material if any is directly charged to the production of the period in total cost.

  • Labour:

The labour costs are collected periodically on a regular basis through pay rolls which are prepared separately for each work department.

  • Chargeable Expenses:

Expenses other than material and labour are chargeable expenses like excise duty, royalty, expenses on designs, patterns and models.


Overhead – Another Element of Cost

Overhead consists of all the indirect costs. Overhead is also known as the on-cost, supplementary cost, burden cost etc.

Overhead consists of three elements:

  1. Indirect materials

  2. Indirect labour 

  3. Indirect expenses

  • Indirect materials – These materials cannot be conveniently identified with the individual cost units. They are generally of minor importance. Examples of indirect materials are - coal, lubricating oil, sand paper, soap, etc.

  • Indirect labour –This cannot be identified with a particular cost unit. Indirect labour is not engaged in the production process directly but only this is indirectly and this assists in the production operations. Examples of indirect labour are peon, supervisor, clerk, watchman etc.

  • Indirect expenses – All kinds of indirect costs, other than the indirect materials and indirect labour costs, are termed as indirect expenses. This cost cannot be directly identified with a particular job, process or identified with work order and is common to cost units and cost centres. Examples of Indirect expenses - rent and rates, insurance, depreciation, power and lighting, cartage, advertising.

 

Cost Centre in Cost Accounting

A cost centre is a department or function within an organization which does not directly add to the profit but still incurs costs the organization money to operate effectively. Cost centres merely contribute to a company's profitability indirectly. Managers of cost centres, like human resources and accounting departments. They are responsible for keeping their cost line in low budget.  

Thus, to sum up:

  • A cost centre is a function within an organization which does not directly add to the profit but still costs money to operate, like working in the accounting, HR, or IT departments. 

  • The main use of a cost centre is to track the actual expenses for comparison to the budget.

  • A cost centre indirectly contributes to a company’s profit professing in operational excellence, customer service, with enhanced product value.

  • The manager is only responsible for keeping the costs in line with the budget and who does not bear any responsibility regarding the revenue or in investment decisions.

FAQ (Frequently Asked Questions)

1. What is Price?

Ans. A price is the quantitative payment or the compensation which is given by one party to another party in return for one unit of goods or services. A price is influenced by production costs, supply of the desired item, and the demand for the product. A price can be determined by a monopolist or may be imposed on the firm by the market conditions.

2. What is Direct and Indirect Cost?

Ans. A direct cost is the price which can be directly tied to the production of the specific goods or services. However, some costs, like the indirect costs are more difficult to assign to a specific product. Examples of the indirect costs are depreciation and administrative expenses.

3. What Do you Mean by Royalty?

Ans. A royalty is a type of legal payment which is made to an individual, for the ongoing use of his or her created assets, which includes copyrighted works, franchises and other natural resources. Royalty payments include the percentage of the gross or the net revenues that is obtained from using the owner's property.

4. What are Human Resources?

Ans. Human resources abbreviated as HR is the division of a business which is responsible of finding, screening, recruiting the employees, and training the job applicants, as well as administering with employee-benefit programs.