Elements of Cost and the Statement of Cost of Production: An SPM Guide

When a firm manufactures its own goods, it cannot just record "purchases" the way a trading business does. It must work out the true cost of finishing each unit, from raw materials and workers' wages through to the cost of running the factory. That is why the elements of cost and the statement of cost of production are the foundation of the manufacturing accounts topic in KSSM Principles of Accounting (code 3756).

This guide covers each element of cost, the order of the statement of cost of production, and the common mistakes that cost candidates marks.

What are the elements of cost?

The elements of cost are the components that make up the cost of a product. They fall into two broad groups: direct costs and indirect costs. Direct costs can be traced straight to the product, while indirect costs cannot be linked to a single unit and must be apportioned.

Understanding this distinction matters because it decides where each cost sits in the statement of cost of production. Misplacing a single item can change your prime cost and your overall cost of production.

The three direct costs and Prime Cost

There are three kinds of direct cost. First, direct materials: the raw materials that become part of the finished product, such as timber used to make furniture. Second, direct labour: the wages of workers directly involved in production, for example the wages of tailors in a clothing factory. Third, direct expenses: costs traceable straight to the product, such as design royalties or the hire of a special machine for a particular order.

The total of these three direct costs is called the Prime Cost. The formula is: Direct materials + Direct labour + Direct expenses = Prime Cost.

Indirect costs: Factory overheads

Indirect costs are known as factory overheads (production overheads). They include indirect materials (such as lubricating oil and cleaning supplies), indirect labour (supervisors' and maintenance workers' wages), and indirect expenses.

Common indirect expenses include depreciation of factory machinery and buildings, factory rent and rates, factory insurance, and factory electricity and water bills. Remember: only the portion relating to the factory is included as a factory overhead. Office, selling and distribution costs are not part of the cost of production; they go into the profit and loss account later.

Cost of raw materials consumed

Before we can enter direct materials into prime cost, we must calculate the value of raw materials used, not those bought. The order is: opening stock of raw materials + purchases of raw materials + carriage inwards (and import duty, if any) - purchase returns - closing stock of raw materials.

The result is the cost of raw materials consumed, and this figure becomes the first line in the prime cost calculation. Students often forget to deduct closing stock or misplace carriage inwards; both mistakes are easy to avoid if you follow the format carefully.

The order of the statement

The statement of cost of production is arranged in a logical flow. Begin with the cost of raw materials consumed, then add direct labour and direct expenses to arrive at Prime Cost. Next add the factory overheads.

The final step is the work-in-progress adjustment (partly finished goods). Add opening work-in-progress and deduct closing work-in-progress. The final total is the Cost of Production, the cost of goods completed during the period. This figure is then transferred to the trading account in place of "purchases".

Common candidate mistakes

Among the most frequent errors: mixing factory costs with office costs, misclassifying direct labour as an overhead, and forgetting to adjust for work-in-progress. Many also confuse the stock of raw materials with the stock of finished goods.

The best way to avoid these is to keep asking: "Does this cost occur in the factory, and can it be traced directly to the product?" That question guides you to place each item in the right place.

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FAQ

Is advertising included in the cost of production? No. Advertising is a selling and distribution expense, so it goes into the profit and loss account, not the statement of cost of production.

What is the difference between prime cost and cost of production? Prime cost is the total of all direct costs only. Cost of production is prime cost plus factory overheads and the work-in-progress adjustment. And what about a factory supervisor's salary? That is indirect labour, so it sits under factory overheads.