Monday 5 March 2018

How to reduce product costs?

Product costs are related to the products or services that generate an entity’s revenues.  These costs can be separate into three components: direct material, direct labor, and production overhead.

Product costs
A direct cost is one that is distinctly traceable to a specify cost object. A cost object is anything of interest or useful informational value, such as a product, service, department, division, or territory. Costs that must be allocate or assign to a cost object using one or more predictors or cost drivers are calls indirect (or common) costs.

Different cost objects may be designate for different decisions. As the cost object changes, the costs that are direct and indirect to it may also change.

For instance, if a production division is specify as the cost object. The production division manager’s salary is direct. If, instead, the cost object is a sales territory and the production division operates in more than one territory. The production division manager’s salary is indirect.

Direct Material

Any readily identifiable part of a product is call a direct material. Direct material costs theoretically should include the cost of all materials use in the manufacture of a product or performance of a service. However, some material costs are not conveniently or practically traceable from an accounting standpoint. Such costs are treat and classify as indirect costs.

For example, in producing gallon-size kitchen storage bags the polyethylene raw material, dye to highlight the bag zippers, and packaging for the bags are all costs for the materials need in production. Because the dye cost is not easily traceable or monetarily significant to production cost. this cost may be classify and account for as an indirect material and include as part of overhead.

Direct Labor

Direct labor refers to the individuals who work specifically on manufacturing a product or performing a service. Another perspective of direct labor is that it directly adds value to the final product or service. The chef preparing the meals at the local restaurant and the dental hygienist at the dental clinic represent direct labor workers.

Direct labor cost consists of wages or salaries paid to direct labor employees.  Such wages and salaries must also be conveniently traceable to the product or service.  Direct labor cost should include basic compensation, production efficiency bonuses, and the employer’s share of Social Security and Medicare taxes. In addition, if a company’s operations are relatively stable, direct labor cost should include all employer-paid insurance costs. Such as holiday and vacation pay, and pension and other retirement benefits.


The Overhead is any factory or production cost that is indirect to manufacturing a product or providing a service. Even and, accordingly it does not include direct material and direct labor. Overhead does include indirect material and indirect labor as well as any and all other costs incurred in the production area.

As direct labor has become a progressively smaller proportion of product cost in recent years, overhead has become progressively larger and merits much greater attention than in the past.

The following comments reflect these fundamental changes in the way manufacturing is conduct:

Automation, technology and computerization have shift costs, making the typical manufacturing process less labor intensive and more capital intensive.  This shift has change the cost profile of many industries. No longer do direct materials and labor costs make up the major portion of total product cost. Instead, overhead, which is share by many products and services, which can be the dominant cost.

No comments:

Post a Comment