Material cost calculation
Material cost is the cost of materials used. Steps: buy, store, issue to production. When the same material was bought at different prices, we need an issue rule:
- FIFO: the oldest lot is used first, at its own price.
- Average: all stock has one average price = total cost ÷ total units.
Materials are direct if they become part of one product (wood in a chair) and indirect if they are small or shared (glue, nails, cleaning cloth). Indirect materials go to overhead.
Records used: purchase record, stock card (units in, out, balance) and issue slip.
Labour cost calculation
Labour cost is the pay for work in the factory. Two common ways to pay:
- Time rate: pay = hours worked × rate per hour. Simple, but does not reward speed.
- Piece rate: pay = pieces made × rate per piece. Rewards speed; quality must be checked.
Direct labour works on the product (the carpenter). Indirect labour helps the whole factory (supervisor, cleaner, storekeeper) and goes into overhead. Overtime and holiday pay are also counted in labour cost.
Overhead expense calculation
Expenses are all costs other than material and labour. They are found in three ways:
- Paid for a period: rent, insurance. Monthly cost = yearly amount ÷ 12.
- Measured by use: electricity by meter units × rate, water by usage.
- Spread over years: depreciation of machines. Straight-line depreciation = (cost − residual value) ÷ life in years.
A few expenses are direct (for example hire of a special machine for one job). Most are indirect and become factory overhead, to be shared by jobs in the next lesson.
Direct and indirect: where each cost goes
After step one, every cost has a label:
| Direct (to the job) | Indirect (to overhead) | |
|---|---|---|
| Material | Wood in a chair | Glue, nails |
| Labour | Carpenter | Supervisor, cleaner |
| Expenses | Special hire for one job | Rent, power, depreciation |
Direct costs are added to the job at once. Indirect costs are collected in a pool and shared later by a rate.
Key formulas and definitions
- FIFO issue cost = units from oldest lot × its price, then next lot
- Average price = Total cost of stock ÷ Total units
- Time wages = Hours worked × Rate per hour
- Piece wages = Pieces made × Rate per piece
- Monthly rent = Yearly rent ÷ 12
- Straight-line depreciation per year = (Cost − Residual value) ÷ Life in years
Worked examples
1. Stock: 10 units at 4 and 20 at 5. Issue 15 units by FIFO. Find cost issued and stock value left.
Issue: 10 × 4 = 40 and 5 × 5 = 25, total 65. Left: 15 × 5 = 75. Check: 65 + 75 = 140 = 40 + 100.
2. Same stock, issue 15 units by average cost.
Average = 140 ÷ 30 = 4.67. Issue = 15 × 4.67 = 70. Left = 70.
3. A worker makes 45 pieces at 2 per piece. Wages?
45 × 2 = 90.
4. A worker is paid 8 per hour and works 6 hours. At what number of pieces would a 2 per piece rate pay the same?
Time wage = 48. 48 ÷ 2 = 24 pieces.
5. Machine cost 1,000, residual value 100, life 9 years. Yearly depreciation?
(1,000 − 100) ÷ 9 = 100 per year.
6. Yearly rent 600, power 30 units at 3, and monthly machine depreciation 100. Find the monthly factory expenses.
Rent 600 ÷ 12 = 50. Power 30 × 3 = 90. Depreciation 100. Total = 50 + 90 + 100 = 240.
Common mistakes
- Averaging the two prices (4 and 5 give 4.5) instead of total cost ÷ total units.
- Putting a cleaner's wages in direct labour. They help all products, so they are indirect.
- Using the whole machine cost as this month's expense instead of spreading it by depreciation.
- Forgetting to deduct residual value when finding depreciation.