Production Costs – Definition, Examples, How to Calculate, and Elements – The production process is the main operational activity of an industry or manufacturing company. The company will take into account the existence of production costs when processing begins from raw materials into ready-to-use or semi-finished goods.
The calculation of production costs is quite complex because there are many types of expenditure components in manufacturing companies. For this reason, further understanding related to it is quite important. The following is a review regarding production costs , starting from the definition, examples, how to calculate, and the elements.
1. Definition of Production Costs
Production costs are costs incurred by the company during the manufacturing or management process with the aim of producing products that are ready for market. The calculation of production costs will be carried out starting from the beginning of processing, until finished or semi-finished goods.
The accumulated expenses required by the company to be able to process raw materials into finished products are referred to as production costs. The scope of production costs contains 3 elements, namely raw materials, direct labor, and factory overhead.
Production costs will be borne by the company until the processing produces goods that are ready to be sold on the market. Later, these costs will be calculated per unit of product, making it easier to calculate and retrieve profit figures.
These costs will later lead to the formation of the cost of finished goods at the end of the accounting period. The total economic sacrifice used in the processing of raw materials to become finished goods and ready to be marketed is called production costs.
Company expenses in the form of production costs are also interpreted as expenditures that are definitely needed to produce finished goods. The nature of these costs is widely considered to be incurred as long as the production of goods is still ongoing.
The characteristics of production costs are different when compared to operating expenses. Operational costs are usually incurred by companies to support the company’s managerial system, while production costs are for managing ready-to-sell goods.
As one example is when you build a building that requires precise calculations in order to do it precisely and quickly. A book entitled The Smart Book for Calculating Building Costs by Rio Manullang can help Sinaumed’s understand this.
2. Types of Production Costs
Classification of production costs is very important for companies to know what types of expenses are needed during the processing of goods. A company needs to classify production costs in order to facilitate the calculation of cost of goods later.
The classification of production costs has an influence on the calculation of the company’s financial statements. Companies must be able to understand correctly what types of production costs are, so they can calculate them appropriately.
In general, there are 5 types of production costs that are known to accumulate expenses when managing goods. Check out the reviews regarding the types of production costs that exist in manufacturing companies in the following details.
2.1 Fixed Costs
Variable costs are expenditures whose amount will not change, even though the volume of production of goods has increased or decreased. This type of cost has a certain nature, so it can be budgeted appropriately.
Fixed cost elements have the same nominal amount that must be paid in each production process. Fixed costs will not experience swelling even though the production process is busy, so it can increase output.
The company can plan a budget for these fixed costs because they are certain, so there is no need to worry about additions or reductions. These fixed production costs will usually be incurred as long as the production process is still running.
One example of fixed costs that must be paid by the company in the same amount, even though the volume of production changes is the cost of factory rent. The company is required to pay these fees regularly according to the agreed price.
Another form of fixed costs is the company’s expenses to pay employees’ monthly salaries. Another company expense that is also fixed is salary costs for factory security guards who use a monthly payment system.
2.2 Variable Cost
The next type of company production expenditure is variable costs, the amount of which depends on output. If the production of goods is higher, the variable costs will also increase.
Variable costs will only be required during the production process, so that they become the basis for spending per unit to be reported. The type of variable cost that is required in the production process is the purchase of raw materials.
Expenditure to purchase raw materials will usually be influenced by output targets during the production process. This variable cost will always change as long as the production process changes.
When the production process stops, it means that the variable costs incurred by manufacturing companies are zero. Variable cost is an important component of production costs to determine the price of goods when marketing takes place, in a matter of per unit.
2.3 Average Cost
Average cost is the cost per unit that will be obtained by dividing the total expenditure by the amount of production output. This average cost is needed by the company to determine future production decisions.
The cost of production per unit will be known by calculating this average cost. Furthermore, the company can determine the percentage of profit to be achieved from the average cost. Average cost will be compared with fixed costs when making production decisions.
From the results of the comparison, information will be obtained about which costs are higher between fixed and variable costs. This can be used as a benchmark for the company to determine the ideal profit.
2.4 Marginal Cost
Marginal costs can also be referred to as additional expenses that will be used by companies to increase production. Companies can find out the maximum amount of output that can be obtained during the production process by adding marginal costs.
Marginal cost calculation is done by adding the variable cost during the production process. Companies can also associate fixed costs with marginal costs when producing additional output.
The function of marginal costs is to help companies maximize overall operational activities. This will enable the company to achieve the maximum profit value of the product more efficiently.
Marginal costs can only be calculated after the fixed and variable costs are known by the company. Marginal cost calculation is done by dividing the increase in cost and the change in production target quantity.
2.5 Total Cost
The last type of production expenditure is the total cost obtained from the combination of variable and fixed costs. This total cost will be information regarding the total amount of expenses incurred during the production process.
This total cost can only be calculated when the company already has output in the form of finished goods ready for sale. Calculation of this total cost must be done every production period is completed so that it can be reported immediately.
This total cost is comprehensive because it includes all company expenses during the production process. The cost of raw materials, administration and marketing must be taken into account in this total cost.
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3. Example of Production Cost
Production costs are taken into account during the product processing process in a business in a manufacturing company. One example that will be discussed this time is a manufacturing company engaged in the food sector where the output is noodles.
In this case the Healthy Food Company produces ready-to-cook yellow noodles with an output of 4,000 packs of finished goods for one month. The following is a breakdown of the yellow noodle production costs for one month.
Cost of purchasing raw materials = Rp. 11,000,000
Direct Labor Cost = Rp. 3,500,000
Factory Security Guard Wages = Rp. 2,000,000 (only during the production process)
Factory Rental Cost = Rp. 1,500,000
The total production cost incurred to produce 4,000 packs of yellow noodles is IDR 18,000,000. From the total expenditure, the production cost per unit can be determined by dividing the total cost by the total number of products. The calculation is Rp. 18,000,000 : 4,000 = Rp. 4,500.
Furthermore, the company can determine the selling price by calculating the cost of production per unit plus the percentage of profit.
In this yellow noodle product, the profit percentage used is 40% of production costs. So, the calculation of the selling price per unit is Rp.4500 + (40% x Rp.4500) = Rp. 6,300
The company will be able to determine the selling price more precisely by knowing the total cost of production. In addition, this cost information is also useful for companies to minimize potential risks during the production process.
4. How to Calculate Production Costs
Calculation of production costs will later be used as a reference to determine the value of the cost of production. There are several steps that need to be taken in calculating this production cost.
As an illustration of the production calculation, below is presented the expenditure data of PT Antara for one month. PT Antara is a company engaged in the production of hijab with a total output of 5,000 units for one month.
Hijab products from PT. Antara is marketed through 3 large stores and e-commerce. The following is PT Antara’s expenditure report data for one month.
- Raw material inventory IDR 30,000,000
- Semi-finished raw materials Rp. 40,000,000
- Finished goods ready for sale Rp. 80,000,000
- Purchase of raw material inventory Rp. 50,000,000
- Shipping costs IDR 5,000,000
- Machine maintenance costs IDR 5,000,000
- Direct labor salary Rp. 30,000,000
- Remaining use of raw materials and remaining semi-finished materials Rp.30,000,000
- The remaining semi-finished materials Rp. 5,000,000
- Hijab ready for sale Rp. 30,000,000
Once the expenditure data is known, then production costs can be calculated. The following are the steps taken to calculate the production costs.
Raw materials used = initial balance of raw materials + purchases of raw materials – ending balance of materials
= Rp. 30,000,000 + (Rp. 50,000,000 + Rp. 5,000,000) – Rp. 30,000,000
= Rp. 55,000,000
Production Costs = raw materials + direct labor + factory overhead costs
= IDR 55,000,000 + IDR 30,000,000 + 5,000,000
= IDR 90,000,000
Production costs per unit = production costs: total units
= Rp. 90,000,000 : 5,000
Cost of Production = total production costs + beginning inventory balance – ending balance
= IDR 90,000,000 + IDR. 40,000,000 – Rp. 5,000,000
= Rp. 125,000,000
Cost of Goods Sold = Cost of production + initial inventory – ending inventory
= Rp. 90,000,000 + Rp. 80,000,000 – Rp. 50,000,000
= Rp. 140,000,000
Related Books :
1. Utilization of Excel 2010 to Prepare Production Budget
2. Production Management Book
5. Elements of Production Costs
Production costs in manufacturing companies are divided into 3 types which include the process of obtaining raw materials to become goods ready for sale. The following are elements that need to be included in the production costs of manufacturing companies.
5.1 Cost of Raw Materials
The first element that must be included in production costs is the cost of raw materials. This cost is used to obtain the main materials that will be used to process the product. Acquisition of raw material costs is obtained from the purchase and processing of the main material.
There are several things related to the company’s raw material costs. The first component in the raw material cost is the cost incurred for purchasing. Companies can buy this raw material either by debit, credit or import from outside suppliers.
The cost component that must be spent on raw materials is the expenditure for warehousing purposes. Raw materials that have been purchased by the company need to be distributed to the warehouse to plan which material will be processed first.
Raw material costs also take into account other acquisition expenses, including during the delivery process. This production expenditure arises because of the calculation of the cost of raw materials purchased by the company.
Cost elements that are definitely taken into account in the acquisition of raw materials include the purchase price, shipping costs, and warehousing costs until they are ready for processing. While the cost of receiving disassembly, and ordering is often not included, because it is difficult to calculate.
Recording of raw material purchases will usually be adjusted to the nominal on the invoice. The transaction document will contain information regarding the cost of purchase, freight charges, and VAT.
5.2 Direct Labor Costs
Direct labor costs are the budget required by the company to pay the salaries of production employees. Direct labor is a company employee who is directly related to the production process.
The salaries of these production employees will be calculated starting from the processing of raw materials to finished products. One example of employee salaries that can be included in direct labor costs is the wages of machine operators.
Components of direct labor costs in professional manufacturing companies do not only include the base salary of employees. Other costs such as employee benefits and insurance are also included in the direct labor cost calculation.
This direct labor cost budget can be done by planning employee needs in advance. Furthermore, the company can determine the basic wage that will be received by direct workers in accordance with the division of their duties.
Companies also need to supervise the performance of direct workers so that salaries can be distributed properly according to the quality of work. This direct labor cost will be calculated in the production cost per unit.
5.3 Factory Overhead Costs
Other expenses related to the production process excluding raw materials and direct labor are called factory overhead costs. These overhead costs often arise due to additional material costs, production control processes, and taxes.
Factory overhead costs will later be calculated in the income statement after the accounting period is over. This cost element has an important role to maximize the production process.
Production-related labor wage payments that cannot be charged to product output will be included in factory overhead costs. There are also machine maintenance and factory rental costs which will also add to overhead costs.
Factory overhead can also be included in variable costs which can change accordingly. production volumes. Examples of factory overhead costs that follow production volume are purchasing factory equipment and paying for factory electricity.