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.