May 16, 2021

SB-Accounting

Accounting + Finance Blog

Elements of cost: Meaning and Classifications

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Cost accounting generally deals with the cost of producing goods and rendering services. Knowledge of this cost can help businesses set up a good pricing policy for their product and services that will earn a reasonable profit margin. In this lesson, we will look at these elements of costs in detail.

Meaning of elements of costs

The elements of cost are those separate items of cost that make up a firm’s costs of producing a product or rendering a service.

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Elements of costs

Generally, three elements of costs exist. Material cost, labor cost, and expenses. However, these costs can also be looked at as either direct or indirect. So, there are direct material costs, direct labor costs, and direct expenses. Also, indirect material cost, indirect labor cost, and indirect expenses.

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However, the cost of production can further be classified as prime cost and overhead cost. While prime costs are all direct costs started above, overheads are majorly indirect costs. Despite these various ways of classifying the elements of costs, the main focus here is on material, labor, and expenses.

Material costs: Material costs are items or materials purchased and used up in the process of producing a good or rendering a service.

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In a firm producing furniture, the wood purchased to make the furniture constitute a major part of the material cost. Others are nails, clothing materials and so on.

For a service firm, for example, a plumber, the material cost may include pipes and other materials required to carry out his services.

Labor cost: Labour costs are the remuneration paid to the human efforts put into the production of a good or the rendering of services. Labor cost may also be referred to as wages and salaries paid to individuals who had put in efforts to ensure the production of the product or the rendering of service is complete.

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As in the example above, the individuals who worked to ensure that the furniture is produced are paid either wages or salaries or labor costs. This also applied to the plumbing services.

Expenses: These are costs other than material costs and labor costs. This means that any other costs you cannot classify as material or labor are classified as expenses.

In the production of furniture, the business owner may pay for the electricity bill. This cannot be classified as material nor labor cost, then, it is strictly classified as expenses. This also applies to the plumber. He may also include transport fees for moving to and fro to where he or she is rendering the service on a daily basis until the job is completed. Such transport fares are classified as expenses.

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These three costs make up the cost of producing goods or rendering the services. Next, we will elaborate on the cost base on direct and indirect costs.

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