8/30/2021

MANUFACTURER’S COST
Dr. Ali Shash

Introduction

 Manufacturing costs are the costs

necessary to convert raw materials into
products. All manufacturing costs must be
attached to the units produced for external
financial reporting. The resulting unit costs are
used for the balance sheet and for the
calculation of the cost of goods sold on the
income statement.

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Introduction
 Manufacturing costs are typically divided into three
categories...
 Direct materials. This is the cost of the materials which
become part of the finished product.
 Direct labor. This is the cost of the wages of the individuals
who are physically involved in converting raw materials into
a finished product.
 Equipment Direct Cost. This is the cost of equipment that are
involved in converting raw materials into finished product.
(Construction)

Introduction
 Factory overhead or manufacturing overhead.
Factory overhead refers to all other costs incurred in
the manufacturing activity which cannot be directly
traced to physical units in an economically feasible
way. The wages of the person who inspects the
completed products and the depreciation on the
factory equipment are part of the factory overhead
costs. Factory overhead is also described as indirect
manufacturing costs.

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Introduction
 Manufacturer’s Cost: (The price of any item you purchase)
 Material
 Labor to Produce Marketable items
 Tool & Equipment
 Permits
 Licenses
 Insurance
 Advertising Cost
 Business Cost
 Profit
 Hard - Cost: Cost of an item after it is actually produced

 Estimate-Cost: Pricing an item before producing it. (This is the heart of the
Construction Industry).

COST THEORY
 In economics, the cost-of-production theory of value is the theory
that the price of an object or condition is determined by the sum of
the cost of the resources that went into making it. The cost can
compose any of the factors of production (including labor, capital, or
land) and taxation.
 COST: Means monetary (Riyal (SR) Exchange for goods or services.
 Example: Money paid for
 Materials
 Labors
 Bonds
 Insurance
 etc…..

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COST THEORY
 Realizing and recording these costs are conducted for two
purposes:
 Purpose 1: Recording the transaction between the
contractor and the environment. For the purpose of
showing the transaction
 Financial statement
 Income statement
 Tax purposes (Zakah)
 Financial accounting (Show the standing of the contractor)
 Business accounting
 External accounting

COST THEORY
 Purpose 2: Recording costs for the
purpose of collecting information to aid
management in the decision making
process. Hence it is called Decision
Making Cost
 Cost Accounting
Internal Accounting
Cost Accounting

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COST THEORY

 This course deals with the decision making costs.

 Financial Accounting is given in ACCT 501.
 Proper cost accounting assigns the various types of costs that
occur to a defined and useful cost objection.

COST THEORY
Classification of Decision-Making Cost
 Assigns various types of costs that occur to certain cost object.
 Cost object: is an activity or part of an organization for which
a separate determination of cost is needed.
 Cost object definition consistent with the management decision
making. For example, if the cost object is the project
superintendent for job overhead, then a job overhead cost
object should be set up for each individual job.

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COST THEORY
Classification of Decision-Making Cost

 The cost object could be:

 By type of cost (Terms of Trade)
 Excavation cost

 Carpentry

 Formed concrete.

 Analytical & in fixed and variable costs

 Fixed Cost: Costs that do not vary with changes in
activity (Relevant range of business activity is the
level of activity for which the firm budgets expects
to operate)

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COST THEORY
Classification of Decision-Making Cost
 Fixed Costs:
Total Unit
 Total Cost Cost
Cost
 Unit Cost

Quantity Quantity

 Semi-fixed Cost:
 The fixed cost may change substantially if the level of activity change
substantial
Total
Cost

Quantity

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COST THEORY
Classification of Decision-Making Cost
 Variable Costs: Costs that vary directly with changes in
activity:
 Total Cost Total Unit
Cost
 Unit Cost Cost



Quantity Quantity


 Observing Both Variable & Cost Function

 Total
 Cost


Quantity

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COST THEORY
Classification of Decision-Making Cost
 Functional Classification
 Direct / Indirect Cost Cost Overhead
 Center
 Type Product
 Direct Cost
 Cost Center: Division or product group where costs are allocated for further
distribution to the products.
 Indirect Costs apportioned to product by
 Value
 Quantity
 Time
 Direct Cost:
 Direct Material Cost
 Direct Labor Cost

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COST THEORY
Classification of Decision-Making Cost

 Direct Material Cost:

 Constitute an appreciable part of the finished product.
 Concrete
 Door & Windows
 Steel, etc……

 Direct Labor Cost:

 Costs involved in the transformation of material into a product
 Carpenter
 Laborer
 Ironworker
 Concrete placement
 Foreman

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COST THEORY
Classification of Decision-Making Cost

 Overhead Costing
 Includes all the costs necessary for the manufacturing operation of the
firm that cannot directly identified with a given product.

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COST THEORY
PRINCIPLES OF COSTING
 Costing Methods
 Full Costing

 Direct Costing

 Full Costing:
Full cost for a product = all costs for that product until
it is delivered and paid for.
 There are two basic principles for full costing:
 Average Costing
 Absorption Costing

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COST THEORY
PRINCIPLES OF COSTING
 Average Costing: Requires uniform production
 Pure average
 Weighted average (For approximate
Uniform Production)
 Calculation with normal (standard) cost.

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COST THEORY
PRINCIPLES OF COSTING
 Concrete Mixer
 Capacity = 60,000 m3 (Normal Production), Quantity Sold (This year) = 40,000 m3

Items Costs Remarks

Stone material $136,000
Cement $240,000
Wages $16,000 (1/2 of which fixed)
Service, repair, maintenance $24,000 (4000 Fixed)
Testing $4,000
Other (fixed cost) $50,000
Total $470,000
 Average (Pure)
 (Full) Cost = 470,000/40,000 = $11.75/m3

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COST THEORY
PRINCIPLES OF COSTING
 Normal Cost
 Break cost into a) Fixed b) Variable

Items Variable Fixed

Stone material $136,000
Cement $240,000
Wages $8,000 $8,000
Service, repair, maintenance $20,000 $4000
Testing $4,000
Other (fixed cost) $50,000
Total $408,000 $62,000
 (Full) Cost = ($408,000/40,000) + ($62,000/60,000) = $11.20/m3

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COST THEORY
PRINCIPLES OF COSTING

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COST THEORY
PRINCIPLES OF COSTING
 Absorption Costing:
Fixed (GOH)
Cost Overhead
Variable Center
Type of (JOH) Product
Cost Direct Cost

 Example of Basis for Apportionment

 Indirect Material - Direct Material Value Q
 Indirect Labor - Direct Labor Time
 Manufacturing Charges = Σ Material & Labor
 (Direct & Indirect)

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General Model (Cars, TV, Manufactured)

Profit

Selling

Office Overhead

Manufacturing Cost
Manuf. Charges
Price
Indirect Material OH

Full Cost
Indirect Labor

Direct Material
Prime Cost
Direct Labor

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Estimated Cost (Construction)

Profit

Contingency

Office Overhead

Bid Price
Manufacturing Cost

Indirect Material
Estimate Cost

Field OH
Indirect Labor

Direct Material
Prime Cost
Direct Labor

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COST THEORY
PRINCIPLES OF COSTING

 Direct Costing
 Contribution Analysis
 Rationale:
 Fixed cost are independent of number of sold units.
 Variable costs change.
 In a facility that already available only the variable costs
expresses real costs to produce the product.
Price

Contribution

Variable Cost

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COST THEORY
PRINCIPLES OF COSTING
 Comparison between Full Costing & Direct Cost:

Full Costing Direct Costing
Price Price
Full Net Profit Var. Cost Contribution

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COST THEORY
PRINCIPLES OF COSTING
 Full Costing  Direct Costing
 1. Price 150
 1. Material  Var. Cost
 Direct $ 20.00  Material -20
 Indirect 2.00 22.00  Labor -40
 2. Labor  Contribution 90
 Direct 40.00  can be used to help cover fixed cost.
 Indirect 60.00 100.00 As a decision making cost:
 Manufacturing Cost 122.00  What if the price is $140.00
 3. Selling Cost 10% 12.2  Full costing
 4. Administration Cost 5% 6.1  Loss Do not manufacture
 Full Cost $ 140.30  Direct costing
 Price 150.00  ? May manufacture
 Profit 9.70

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COST THEORY
 Opportunity Cost
 Failure to take advantages of other opportunities result in foregoing
profits or benefits that otherwise would have been obtained.
 Sunk Cost
 The past (or continuing) cost related to past decisions which
unrecoverable by current or future decisions.
 Example
 The cost associated with the feasibility study for a project.
 A lot of research has been devoted to analyze the development of a
certain project and it appears that the likelihood of success is very small.
In considering whether to continue with the research or not, the labor that
has been spent in the past is irrelevant, because it has no opportunity
cost and it cannot be recovered.

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Characteristics of the Construction Industry

 The physical nature of the product

 Large, heavy, and Expensive
 Required over a wide geographical area
 Customer Tailored
 A large part of the components are manufactured elsewhere.


 The ultimate use of the product is (Types of Projects)

 As a mean to further production
 As an addition to or improvement of the infrastructure of the
economy (e.g. roads)
 As social investment (e.g. Hospitals)
 As an investment for direct enjoyment (e.g. Housing)

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Characteristics of the Construction Industry

 The demand for the product

 is determined differently for different types of
products
 is largely dependent on governmental policy

 The price determination is a discrete process for

each project and for each piece of work
subcontracted.

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Characteristics of the Construction Industry

 Types of Projects:
 The categorization is based on the specialization of the
contractor. Each contractor is specialized in building
certain type of physical structure. Hence, each
contractor is different in possessing construction
equipment, trade and supervisory skills and filed
procedures.
 Type of Contractors
 Residential contractor
 General building contractor
 Specialty contractor
 Heavy and highway contractor.

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Characteristics of the Construction Industry

 There are two main divisions (projects)

 Building Construction: Includes all projects that are
designed by Architects.
 Housing Construction (Residential)
 High-rise apartment
 Single family homes
 Garden-type apartments
 Non-residential Building Const. Building erected for
 Institutional, Educational, Commercial, Religious, and Recreational
purposes.

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Characteristics of the Construction Industry

 Engineering Constructions: Includes all structures

that are planned and designed by engineer.
 Highway Const. (Roads, Bridges)
 Heavy Construction
 Sewage, Water Treatment, Plants, Dams, etc…
 Utility Construction
 Sanitary & Storm drains, curb and stutter, street, paving, water
lines, electrical and telephone distribution facilities.

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