Direct materials, indirect materials and labour

• It is important to point out at this stage that there are generally three types of entities:
  1. Manufacturing entities that make goods and sell them
  2. Merchandising entities that purchase goods and sell them for a profit for example supermarkets
  3. Entities that provide services for example accounting and law firms
• It is not uncommon to encounter entities that offer combinations of the above though
• Regardless of the type of business involved all these entities have cost objects that are of particular interest to management
• A cost object is any activity for which a separate measurement of costs is needed or required or desired
• Examples of cost of objects include a customer, contract, product, group of products (product mix), department etc
• Costs that are assigned to cost objects can be divided into two broad categories:
  1. Direct costs
  2. Indirect costs
• Both these categories can be further divided into:
  1. Direct material costs
  2. Indirect material costs
  3. Direct labour costs
  4. Indirect labour costs

Direct materials

• Refers to those costs that can be specifically and exclusively identified with a particular cost object
• For example where the cost object is a product in a manufacturing industry such as a bakery direct materials include flour, sugar, salt and cooking oil
• In such instances the direct materials are physically discernible as part of the product i.e. you can actually see them on the product for example wood on a chair is a direct material
• For this reason the cost of direct materials can be charged directly to their various cost objects e.g. product

Direct Labour

• are those labour costs that can be specifically and exclusively identified with a particular cost object
• Physical observation can be used to attribute these costs to their cost objects but in most cases common sense will allow these costs to be allocated to their cost objects
• For example the labour cost of the baker or carpenter involved in baking bread and making a table respectively
• The total of all direct costs are known as prime costs

Indirect costs

• Refers to all those costs that cannot be specifically and exclusively identified with a given cost object
• They comprise of indirect labour, indirect materials as well as as other indirect expenses
• In a manufacturing setting indirect labour includes the wages and salaries of supervisors, security etc
• These individuals are not involved in the direct making of goods e.g. baking
• Indirect materials include cleaning materials, gloves,lubricants etc
• Other indirect expenses include lighting and heating expenses and factory rentals
• The term overheads is often used to refer to indirect expenses

Total Cost of Production

• All the costs mentioned above make up the entire cost of production
• The relationship between all these costs can be summarised as in the table below:

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