Factory cost definition
/What is Factory Cost?
Factory cost refers to the total cost required to manufacture goods. Understanding factory cost is essential for setting prices, as well as for determining the profits being generated by each product. Given its importance, cost accountants typically spend a great deal of time verifying that factory costs have been accurately measured and reported.
The factory cost concept is the basis for several cost accounting analyses. Factory costs have traditionally been broken down into the following three categories of cost:
Direct Materials
Direct materials is the cost of those materials directly associated with the production of goods. It can also include the cost of materials destroyed during the setup and testing of production equipment, as well as a normal amount of scrap.
Direct Labor
Direct labor is the cost of labor directly associated with the production of goods. This category of cost has been called into question, since most production labor is actually needed to provide a minimal level of staffing to the production area, and so should really be considered an overhead cost. Only in cases where labor costs can be specifically associated with a particular unit of production should costs be considered direct labor. For example, if a production worker is paid a piece-rate wage for each unit manufactured, this can be considered a direct labor cost.
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Manufacturing Overhead
The manufacturing overhead category is comprised of all the costs incurred that are needed to run a factory, but which are not associated with a specific unit of inventory. Manufacturing overhead can include, but is not limited to, equipment depreciation, equipment maintenance, factory rent, factory utilities, materials handling staff wages, production supplies, quality assurance staff wages, and supervisor salaries.
Accounting for Factory Costs
Manufacturing overhead is typically assigned to individual units of production, based on a rational and consistently-applied allocation methodology. Direct materials and direct labor costs are also assigned to individual units. Thus, all factory costs are assigned to units of production. As such, these costs are recorded as part of the inventory asset. Once the units are sold, the associated factory cost is charged to expense through the cost of goods sold account.
Variations on the Factory Cost Concept
The "factory cost" term is sometimes applied only to manufacturing overhead costs, without consideration to the costs of direct materials or direct labor. If so, the "factory cost" term is essentially the same as factory overhead.