Cost and Expense

Cost is sacrifice of economic resources for example purchase of machinery, raw material etc and Expense is expired cost that charged against revenue in particular accounting period say depreciation, rent etc.


Elements of Manufacturing Costing

Cost of production/manufacturing consists of various expenses incurred on production/manufacturing of goods or services sold. These are the elements of cost which can be divided into three groups i.e. Material, Labor and Expenses.


elements of cost


1. Direct Material

Direct Material is that material which can be easily identified and related with specific product, job, and process. Timber is a raw material for making furniture, cloth for making garments, sugarcane for making sugar, and Gold/silver for making jewelry, etc. are some examples of direct material.


2. Direct Labor

Labor which takes active and direct part in the production of a product or providing services. Direct labor is that labor which can be easily identified and related with specific product, job and process. Direct labor cost is easily traceable to specific products. Direct labor varies directly with the volume of output. Cost of wages paid to carpenter for making furniture, cost of a tailor in producing readymade garments, cost of washer in dry cleaning unit are some examples of direct labor. 

3. Expenses

All cost incurred in the production of finished goods other than material cost and labor cost are termed as expenses. Expenses are classified into two categories i.e. Direct expenses, and Indirect expenses (Factory Overheads).


3.1 Direct Expenses

These are expenses which are directly, easily, and wholly allocated to specific cost center or cost units and charged to direct material section. All direct cost other than direct material and direct labor are termed as direct expenses. Some examples of the direct expenses are cost of wages, inward carriage and freight, cost of patents, royalties etc.


3.2 Indirect Expenses

These expenses cannot be directly, easily, and wholly allocated to specific cost center or cost units. All indirect costs are indirect material, indirect labor and indirect expenses. Thus, indirect expenses are treated as part of Factory Overheads.


3.2.1 Indirect Materials:

  • Grease, oil, lubricants etc.
  • Small tools, brushes for sweeping, sundry supplies etc.
  • Gum, nails, consumable stores
  • Factory printing and stationery


3.2.2 Indirect Labor:

  • Salary of factory manager, foremen, supervisors, clerks etc.
  • Salary of storekeeper, security staff, time keepers
  • Salary and fee of factory directors and technical directors
  • Contribution to pension fund, leave pay etc. of factory employee


3.2.3 Indirect Expenses:

  • Rent of factory buildings and land
  • Insurance of factory building, plant, and machinery
  • Municipal taxes of factory building
  • Depreciation of factory building, plant and machinery, and their repairs and maintenance charges
  • Power and fuel used in factory
  • Factory telephone expenses


Example # 1:

The following information has been taken from company records. You are required to calculate Direct Material, Direct Labor and Factory Overhead?

calculate Direct Material, Direct Labor and Factory Overhead




direct material

direct labor

factory overhead


Cost of Sales

The term cost of sales use for merchandising or trading business. The cost of sales involves the identification of the expenses that are related to the trading process. Opening stock plus net purchases (with any direct expense) minus closing stock


Example # 2:

Test your understanding?

cost of goods sold (CGS)


Gross Profit, Operating Profit and Net Profit

A company’s net revenue minus its cost of goods sold or cost of sales. Operating profit is gross profit minus commercial expenses of the company. Net profit is operating profit minus (financial charges, taxes and other expenses) plus other income.


 Commercial Expenses

Marketing expenses and administrative expenses are combine called commercial expenses. Following are some examples for commercial expenses

marketing and administration expenses


Example # 3:

Test your understanding?

cost of goods sold problems


Example # 4:

Test your understanding?

cost of goods sold

gross profit


gross profit and net profit

>> Practice Costing Problems and Solutions.