Manufacturing Costs: Direct, Indirect and Total

Counting the cost

Every product costs money to make, and a business that does not know its costs cannot set a sensible price. Working the costs out is a core engineering skill. This module works through it: - Direct costs: the materials and labour that go straight into the product.\n- Indirect costs: the overheads of running the business.\n- Total cost: the direct and indirect costs added together.\n- Unit cost: the cost of making each single item. How things are made, and the materials themselves, are covered in other modules. Here the focus is the costs and the costing calculations.

Words for manufacturing costs

Five terms you need before you use them. Learn what each one means.

Match each cost to its type

Direct costs against indirect costs

Sorting a cost into the right group is the first step of any costing. The two groups behave quite differently.

Which is an indirect cost?

In a factory, which of these is an indirect cost rather than a direct cost?

• The rent paid for the factory building
• The steel used in each product
• The wage of the machine operator making the item
• The plastic moulded into the item

Tap the two direct costs

Tap the TWO costs that are direct costs of making a product.

• The raw materials in the product
• The wages of the workers making it
• The office electricity bill
• The advertising spend

Working out the cost per item

Once you can sort costs, working out what each item costs to make is straightforward, and it drives the price a firm can charge. First add up all the costs that go into the product and all the costs of running the business to get the whole cost of the job. Then share that across the number of items made, and you have the cost of one. A firm sets its price above that figure so it makes a profit. And because the running costs stay much the same, making more items spreads them thinner, so each item costs less. That is one reason larger production runs can be cheaper per item.

Pick the true facts about costs

Select the TWO statements that are true.

• Total cost is the direct costs plus the indirect costs
• Making more items usually lowers the cost per item
• Rent is a direct cost of one product
• Unit cost means the cost of all the items together

Order how to work out a unit cost

Put the steps of working out the cost of one item in a sensible order.

• List all the direct costs of the job
• List all the indirect costs
• Add them to find the total cost
• Count how many items were made
• Divide the total cost by the number of items

One batch of stools, costed

Follow how a small workshop worked out what each stool in a batch really cost.\n\nCosts that went into the stools: the timber and the wages of the maker came to 500 pounds for the batch of 50. Running costs of the workshop: rent, power and office time added another 300 pounds, whatever the workshop happened to make that week. Everything added up: putting the two sets of costs together gave 800 pounds for the whole batch. The cost of one: sharing 800 pounds across 50 stools worked out at 16 pounds each, which the workshop used to set a fair selling price. Seeing both kinds of cost stopped them from pricing the stools too low to cover the bills.

Complete the costs facts

A cost tied straight to one product, such as its materials, is a _____ cost. A cost of running the business, such as rent, is an _____ cost. The direct and indirect costs added together give the _____ cost. The total cost shared across each item made is the _____ cost.

Work out the cost per item

A job has direct costs of 600 pounds and indirect costs of 200 pounds, and produces 40 items. First add the two costs to find the total cost, then divide by the number of items to find the cost per item in pounds.

Build a costs point

Choose the words that complete this statement about costing.

Cost it correctly

Read each situation and choose the correct answer, then think about why.

• A firm counts only the materials and forgets the rent and administration. What have they missed?
• A firm wants to lower the cost of each item without buying cheaper materials. What can help?
• A firm sets its selling price exactly equal to the unit cost. What is the problem?

Explain how manufacturing costs are worked out

A classmate finds costing confusing. Explain how manufacturing costs are worked out using what this module has covered.

• Explain the difference between direct and indirect costs, with examples
• Explain what the total cost is
• Explain how to work out the cost per item
• Explain how making more items affects the cost per item
• Finish by explaining why a firm must know its costs before setting a price