Production Costs: Definition, How To Calculate, Examples and Elements

Production Costs – Definition, Examples, Methods of Calculating, and Elements – The production process is the main operational activity of an industry or manufacturing company.

The company will take into account the production costs when the processing starts from raw materials into ready-to-use or semi-finished goods.

The calculation of production costs is quite complex because there are so many types of expenditure components in manufacturing companies.

Therefore, a further understanding of the related is quite important. The following is a review related to the production costs starting from the definition, examples, how to calculate, and the elements.

1. What is Production Costs Definition

Production costs are costs incurred by the company during the manufacturing or management process with the aim of producing products that are ready to be marketed.

The calculation of this production cost will be carried out starting from the beginning of processing, to 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 includes 3 elements, including raw materials, direct labor, and factory overhead.

Production costs will be charged to the company until the processing process produces goods that are ready to be sold in the market. Later, these costs will be calculated for per unit of product, making it easier to calculate and take profit figures.

These costs will lead to the formation of the cost of finished goods at the end of the accounting period. The overall economic sacrifice used in the processing of raw materials to become finished goods and ready to be marketed is called production costs.

The company’s expenses in the form of production costs are also defined as expenses that are definitely needed to produce finished goods.

The nature of this cost is considered to be certain to be incurred as long as the production of goods is still ongoing.

Characteristics of production costs have differences when compared with operating expenses. Operational costs are usually incurred by the company to support the company’s managerial system, while production expenses are to manage ready-to-sell goods.

2. Types of Production Costs

The 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 the 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 correctly.

In general, there are 5 types of production costs that are known to accumulate expenses when managing goods. Check out the reviews related to what types of production costs 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 definite nature, so it can be budgeted accurately.

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 that it can increase output.

Companies can plan a budget for these fixed costs because they are certain, so there is no need to worry about adding or subtracting. These fixed production costs will usually be incurred as long as the production process is still running.

One example of a fixed cost that must be paid by the company in the same amount, even though the volume of production changes is the cost of renting a factory. The company is required to pay these fees regularly in accordance with 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 the cost of salaries for factory security guards who use a monthly payment system.

2.2 Variable Cost (Variable Cost)

The next type of company production expenditure is a variable cost whose amount depends on the output. If the production of goods is higher, then the variable costs will also increase.

Variable costs will only be needed during the production process, so that they become the basis for expenditure per unit that will be reported. The type of variable cost that is needed in the production process is the purchase of raw materials.

Expenditure to purchase raw materials will usually be influenced by the target output during the production process. This variable cost will always change during the production process changes.

When the production process stops, it means that the variable costs incurred by the manufacturing company 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)

Average cost is the cost per unit that will be obtained by dividing the total expenditure by the total production output. This average cost is needed by the company to determine future production decisions.

The production cost 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 costs will be compared with fixed costs when making production decisions.

From the comparison results, it will be possible to obtain information 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 cost can also be referred to as the additional expenditure that will be used by the company to increase production. The company 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 variable costs during the production process. Firms can also relate fixed costs to marginal costs when producing additional output.

The function of marginal cost is to help the company maximize overall operations. This will enable the company to achieve the maximum profit value of the product more efficiently.

Marginal cost 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 the production target quantity.

2.5 Total Cost

The last type of production expenditure is the total cost obtained from combining variable and fixed costs. This total cost will be information about 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 that are ready to be sold. This total cost calculation must be carried out every time the 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.

3. Sample Production Cost

Production costs are taken into account during the product processing process in a business at 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 yellow noodles that are ready to cook with an output of 4,000 packs of finished goods for one month. The following is a breakdown of the production costs of the yellow noodles for one month.

  • Cost of purchasing raw materials = $. 11,000,000
  • Direct Labor Cost = $. 3.500.000
  • Factory Security Wage Cost = $. 2,000,000 (only during the production process)
  • Factory Rental Cost = $. 1,500,000

The total production cost incurred to produce 4,000 packs of yellow noodles is $. 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 $. 18,000,000 : 4,000 = $. 4,500.

Furthermore, the company can determine the selling price by calculating the production cost per unit plus the percentage of profit.

In this yellow noodle product, the percentage of profit used is 40% of the production cost. So, the calculation of the selling price per unit is $ .4500 + (40% x $.4500) = $. 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 Cost

The calculation of the production cost will be used as a reference to determine the value of the cost of production. There are several steps that need to be done in calculating this production cost.

As an illustration of the calculation of production, the following is presented data on the expenditure of ABCDEF, LLC for one month. ABCDEF, LLC is a company engaged in the production of hijab with a total output of 5,000 units for one month.

Hijab products from PT. Between these are marketed through 3 major stores and e-commerce. The following is ABCDEF, LLC ‘s expense report data for one month.

  • Raw material inventory $ 30,000,000
  • Semi-finished raw materials $ 40,000,000
  • Finished goods ready for sale $ 80,000,000
  • Purchase of raw material inventory $ 50,000,000
  • Shipping cost $ 5.000.000
  • Machine maintenance fee $ 5.000.000
  • Direct labor salary $ 30,000,000
  • The remaining use of raw materials and the remaining half-finished materials $ 30,000,000
  • The remaining half-finished materials $ 5,000,000
  • Hijab ready for sale $ 30,000,000

After knowing the expenditure data, then the calculation of production costs can be done. The following are the steps taken to calculate the production costs.

Stage 1:

Raw materials used = initial balance of raw materials + purchase of raw materials – ending balance of materials
= $ 30,000,000 + ($ 50,000,000 + $ 5,000,000) –
$ 30,000,000 = $ 55,000,000

Stage 2:

Production costs = raw materials + direct labor + factory overhead costs
= $ 55,000,000 + $ 30,000,000 + $  5,000,000
= $ 90,000,000

Production cost per unit = production cost : total unit
= $ 90,000,000 : 5,000
= 18,000

Stage 3:

Cost of Production = total cost of production + beginning inventory balance – ending balance

= $ 90,000,000 + $ 40,000,000 – $ 5,000,000
= $ 125,000,000

Stage 4

Cost of Goods Sold = Cost of goods manufactured + beginning inventory – ending inventory
= $ 90,000,000 + $ 80,000,000 – $ 50,000,000
= $ 140,000,000

Related Books:

1. Using Excel 2010 to Prepare Production Budget

5. Elements of Production Cost

Production costs in manufacturing companies are divided into 3 types which include the process of getting raw materials to become ready-to-sell goods. Here are the elements that need to be included in the manufacturing company’s production costs.

5.1 Raw Material Cost

The first element that must be included in the 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. The cost of this raw material 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 the purchase. Companies can buy these raw materials either by debit, credit, or by importing from outside suppliers.

The cost component that must be incurred for raw materials is expenditure for warehousing needs. Raw materials that have been purchased by the company need to be distributed to the warehouse to plan which materials will be processed first.

The cost of raw materials also takes into account other acquisition costs, 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 must be taken into account in the acquisition of raw materials include the purchase price, shipping costs, and warehousing costs until they are ready to be processed. While the cost of receiving, dismantling, and ordering is often not included, because it is difficult to calculate.

The recording of the purchase of raw materials will usually be adjusted to the nominal in the invoice. The transaction document will contain information on the cost of goods purchased, transportation costs, and VAT.

5.2 Direct Labor Cost

Direct labor costs are the budget required by the company to pay the salaries of production employees. Direct workers are company employees who are 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.

The component of direct labor costs in professional manufacturing companies does not only cover the basic salary of employees. Other costs such as employee benefits and insurance are also included in the calculation of direct labor costs.

This direct labor cost budget can be done by planning employee needs in advance. Furthermore, the company can determine the basic wages that will be received by direct workers in accordance with the division of tasks.

Companies also need to supervise the performance of direct workers so that salaries can be distributed properly in accordance with the quality of work. This direct labor cost will be calculated in the production cost per unit.

5.3 Factory Overhead Cost

Other expenses related to the production process outside of raw materials and direct labor are called factory overhead costs. These overhead costs often arise as a result of additional material costs, production control processes, and taxes.

Factory overhead costs will be calculated in the income statement after the accounting period has ended. This cost element has an important role to maximize the production process.

Production-related labor wages that cannot be assigned to product output will be included in factory overhead costs. There are also machine maintenance costs and factory rentals which will also add to the overhead costs.

Factory overhead can also be included in variable costs which can change accordingly. production volume. Examples of factory overhead costs that follow the volume of production are purchases of factory equipment and payments for factory electricity.

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