Cambrige AS and A Level Accounting Notes (9706)/ ZIMSEC  Advanced Accounting Level Notes: Types of Costs: 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:
$
Direct Materialsxxx
Direct Labourxxx
Direct Expenses

xxx

Prime Costxxxx
Overheads

xxx

Total Cost of Production

xxxxx

To access more topics go the ZIMSEC Advanced Level Accounting page

To access more topics go to the Cambridge AS/A level page


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