Manufacturers have a whole host of costs that they must account for in the manufacturing process. The costs may be divided into two categories: direct costs and indirect costs. Indirect costs often are referred to as overhead costs, and result from the use of resources to support the manufacturing process. For instance, electricity used to run the factory is an overhead expense. Direct and indirect inventory expenses must be accounted for using generally accepted accounting principles (GAAP). Proper accounting methods make it simpler to determine direct labor costs and overhead expenses.
Direct Labor Cost
When determining and accounting for direct and indirect labor costs, it is best to begin with the direct labor costs. Direct labor costs are those costs accumulated as a result of workers producing the product. Because this cost is a single cost, it is easier to determine than indirect labor costs. Various factors can go into direct labor costs, but for the most part direct labor can be determined by multiplying the number of units produced by the number of hours required to produce the product. The resulting figure then is multiplied by the cost of labor per hour to determine the direct labor cost for that product. If multiple products are produced, the cost is determined for each product and then added together.
The indirect costs associated with the manufacturing process are any costs not directly attributable to the cost of labor. Therefore, the simplest way to determine the total of a company's indirect costs is to use accounting records to determine the overall expenditures and subtract the direct labor costs from the total cost. Since many expenses are included in these indirect costs, it may difficult to have an accurate and up-to-date figure. Companies often will use estimates based on the previous year's expenditures to determine these costs.
Accounting for indirect and direct labor costs requires that a portion of the overhead for each unit produced be allocated as an expense. This is required to maintain GAAP, but does not necessarily require that the allocated expense be completely accurate. Due to the nature of the calculation of these expenses, estimated totals are acceptable for accounting purposes when it comes to these types of costs. The accounting method used to record indirect costs is through the use of the "cost of goods sold" entry on a company's income statement.
Aside from having financial records that are as accurate as possible given the amount of estimating required, the cost of direct labor and manufacturing overhead can be used to improve efficiency and assign the correct cost to a product. Therefore, although estimates are used, the number must be based on real figures and within a reasonable amount of those figures. Failure to do so could result in management assigning incorrect labor costs and adjusting the price accordingly. This cost then is carried down to the consumer in the form of retail prices.
- Accounting Coach: Manufacturing Overhead
- Accounting for Management: Application of Manufacturing Overhead Cost in Job Order Costing
- Managerial Accounting: A Focus on Ethical Decision Making; Steven R. Jackson et al.; 2009
- Accounting Coach: Manufacturing Overhead -- Financial Reporting vs. Individual Products and Customers
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