Cost Classification as Manufacturing and Non-manufacturing:
Learning objectives of this article:
- Define and explain manufacturing and
- What is the difference between
manufacturing and non-manufacturing costs costs?
- Identify and give examples of each of the three
basic manufacturing cost categories.
Manufacturing firms are involved in acquiring raw
materials producing finished goods and then administrative, marketing and
selling activities. All these activities require costs to be incurred. These
costs are normally classified by manufacturing companies as manufacturing and
non-manufacturing costs. In the following paragraphs we will see how these costs
are classified as manufacturing and
Definition and Explanation of manufacturing cost:
Manufacturing costs are those costs
that are directly involved in manufacturing of products and services. Examples
of manufacturing costs include
raw materials costs and salary of labor workers. Manufacturing cost is
divided into three broad categories by most companies.
The materials that go into final product are called raw materials.
This term is somewhat misleading, since it seems to imply unprocessed natural
resources like wood pulp or iron ore. Actually raw materials refer to any
materials that are used in the final product; and the finished
product of one company can become
raw material of another company. For example
plastic produced by manufacturers of plastic is a finished product for them but
is a raw material for Compaq Computers for its personal computers.
are those material that become an integral part of the
finished product and that can be physically and conveniently traced to it.
Examples include tiny electric motor that Panasonic uses in its CD players to
make the CD spin. According to a study of 37 manufacturing industries material
costs averaged about 55% of sales revenue.
Sometimes it is not worth the effort to trace the
costs of relatively insignificant materials to the end products. Such minor
items would include the solder used to make electrical connection in a Sony TV
or the glue used to assemble a chair. Materials such as solder or glue are
called indirect materials and are included as part of manufacturing overhead,
which is discussed later on this page.
direct labor is reserved for those labor costs that can be
essentially traced to individual units of products.
is sometime called touch labor, since direct labor workers typically touch the
product while it is being made. The labor cost of assembly line workers, for
example, is a direct labor cost, as would the labor cost of carpenter,
bricklayer and machine operator
Labor costs that cannot be
physically traced to the creation of products, or that can be traced only at a
great cost and inconvenience, are termed indirect labor and treated as
part of manufacturing overhead, along with indirect materials. Indirect labor
includes the labor costs of janitors, supervisors, materials handlers, and night
security guards. Although the efforts of these workers are essential to
production, it would be either impractical or impossible to accurately trace
their costs to specific units of product. Hence, such labor costs are treated as
In some industries, major shifts are
taking place in the structure of labor costs. Sophisticated automated equipment,
run and maintained by skilled workers, is increasingly replacing direct labor.
In a few companies, direct labor has become such a minor element of cost that it
has disappeared altogether as a separate cost category. However the vast
majority of manufacturing and service companies throughout the world continue to
recognize direct labor as a separate cost category.
According to a study of 37
manufacturing industries, direct labor averaged only about 10% of sales revenue.
Direct Materials cost combined with
direct labor cost is called
In equation form:
Prime Cost =
Direct Materials Cost + Direct Labor Cost
For example total direct
materials cost incurred by the company is $4,500 and
direct labor cost is $3,000
prime cost is $7,500 ($4,500 + $3,000).
Manufacturing overhead, the third element of manufacturing cost, includes all
costs of manufacturing except
direct material and
direct labor. Examples of manufacturing
overhead include items such as
indirect labor, maintenance
and repairs on production equipment and heat and light, property taxes,
depreciation, and insurance on manufacturing facilities.
minor items such as solder and glue in manufacturing industries. These are not
direct materials costs.
labor is a labor cost that cannot
be trace to the creation of products or that can be traced only at great cost
labor includes the labor cost of janitors,
supervisors, materials handlers and night security guards. Costs incurred for
heat and light, property taxes, insurance, depreciation and so forth associated
with selling and administrative functions are not included in manufacturing
overhead. Studies have found that manufacturing overhead averages about 16% of
sales revenue. Manufacturing overhead is known by various names, such as indirect
manufacturing cost, factory overhead, and factory burden. All of these terms are
synonymous with manufacturing overhead.
Manufacturing overhead cost combined with
direct labor is called
In equation form:
= Direct Labor Cost + Manufacturing Overhead Cost
For example if total direct labor
cost is $3,000 and total manufacturing overhead cost is $2,000 then
conversion cost is $5,000 ($3,000 + $2,000).
Definition and explanation of non-manufacturing cost:
Non-manufacturing costs are those costs that are not
incurred to manufacture a product. Examples of such costs are salary of sales
person and advertising expenses. Generally non-manufacturing costs are further classified
into two categories.
Marketing and Selling Costs
Marketing or selling costs include all costs necessary to secure customer
orders and get the finished product into the hands of the customers. These costs
are often called order getting or order filling costs. Examples of marketing
or selling costs include
advertising costs, shipping costs, sales commission and sales salary.
Administrative costs include all
executive, organizational, and clerical costs associated with general
organization rather than with manufacturing, marketing, or selling.
Examples of administrative costs include executive compensation, general
accounting, secretarial, public relations, and similar costs involved in the
overall, general administration of the organization as a whole.
manufacturing and non-manufacturing costs
Materials that can be physically and conveniently traced to a product, such
as wood in a table.
(Direct Materials + Direct Labor)
(Direct Labor + Overhead Cost)
Labor costs that can be physically and conveniently traced to a product such
as assembly line workers in a plant. Direct labor is also called touch labor
All costs of manufacturing a product other than direct materials and direct
labor, such as indirect materials, indirect labor, factory utilities, and
depreciation of factory equipment.
Marketing or selling
All costs necessary to secure customer orders and
get the finished product or service into the hands of the customer, such as
sales commission, advertising, and depreciation of delivery equipment and
finished goods warehouse.
All costs associated with the general management of the company as a whole,
such as executive compensation, executive travel costs, secretarial
salaries, and depreciation of office building and equipment.