DIRECT COST OR VARIABLE COST:– Direct Cost means which changes on production of each additional unit of a product in a manufacturing firm like cost of raw material, wages to workers, packing charges, cartage inward expenses, electricity and water expenses, other fuel expenses. In other words, direct cost means the cost of a product to make it for selling purpose.
From the point of view of a trading firm, the direct cost means the cost of purchase like Purchase of raw material or semi-finished material or finished material, cartages inward expenses, any wages directly paid on the basis of the items purchased.
Direct cost is called variable expenses also because these expenses vary on each and every additional unit of production in same proportion.
Example:– A manufacturing company prepares the shirts. In this case, direct costs for each shirt should be the cost of cloth and other material required to prepare a shirt, wages paid to worker who prepares the shirt, packing material required for packing the shirt cost of electricity required to run the machine etc. Suppose for manufacturing one shirt comes Rs.300/=. If this unit prepares 100 shirts, the cost will be 30000/=. So, the each additional unit is being prepared after spending Rs.300/=. It is called direct cost or variable cost.
A portion of depreciation of machinery used in production also treated as direct cost. But it depends upon the circumstances of the different cases. In some cases, actual cost of depreciation can be calculated and in some cases an estimated cost of depreciation is included in direct cost of product. Most of the firms take in to consideration the depreciation charges also.
Most important thing is that direct cost is uncontrollable because it is directly related to the unit produced.
INDIRECT COST OR FIXED COST
Indirect cost means which is not direct cost or variable cost. For example for a manufacturing firm, rent for factory, electricity and water expenses of factory other than directly used for manufacturing purpose, salaries paid to supervisors, factory manager and other employees who are indirectly related to a factory and other factory overhead expenses, repair and maintenance of plant and machinery etc. These expenses do not vary according to the quantity of the products.
Some time these expenses also vary according to the production but not in same proportion even these are treated as indirect expenses. For example, the electricity bill of factory increases if the unit is working more than scheduled time, overtime paid to other staff, increment in rent and other incidental expenses relating to factory.
These expenses are also varies according to the production and are not controllable even these are treated as indirect expenses.
Total cost of product means direct cost plus indirect cost. Total cost includes all direct expense and other factory expenses. The direct expenses are totally related to every additional unit produced and allocated easily but indirect factory overheads are allocated on total units of the production.
M/s XYZ Ltd. produced 1000/= shirts in one month and following expenses incurred in respect of production of 1000 shirts:-
Cost of cloth 200000/=
Wages for each shirt Rs.100/=
Other material per shirt Rs. 50/=
Electricity consumed per shirt Rs.5/=
Rent of factory Rs. 10000/= per month
Salary to factory supervisor Rs.10000/= per month
Depreciation on machinery Rs. 12000/= per year
Other factory overheads Rs. 10000/= per month
Calculate the cost of a shirt?
Solution:- Total cost of 1000 shirts
Cost of cloth 200/= per shirt Rs.200000/=
Wages Rs.100/= per shirt Rs.100000/=
Other material 50/= per shirt Rs.50,000/=
Electricity charges Rs.5/= per shirt Rs.5000/=
Total Direct Cost Rs.355000/=
Rent of factory Rs.10000/=
Salary of supervisor Rs.10000/=
Other factory overheads Rs.10000/=
Depreciation (Rs.12000/12) Rs.1000/=
Total Indirect Cost Rs. 31000/=
Total Cost of 1000 Shirts Rs.386000/=
Total Cost of each shirt will be Rs.386/=.
Note: Indirect cost may differ per shirt in case of less or more production according to the capacity of the production and units produced in the same infrastructure.
When we divide the total cost of products by number of total units produced, we will get the figure of one unit. This cost per unit, is called average cost. For example, a firm had spent Rs.100000/= to produce 10000/= unit of some product, the average cost shall be Rs.10/=.
WHAT IS MARGINAL COST?
Any additional cost incurred on production of one additional unit is called marginal cost. For example, cost of one steel chair comes Rs.1000/= and suppose, one more steel chair is also to be prepared and the cost of this additional chair comes Rs.900/=, then in this case the marginal cost for second chair shall be Rs.900/=.
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