Costs of manufacturing goods is called factory cost. This concept is used for valuation of goods which is needed to attach a value to the inventory in hand and to determine the cost of goods sold.
Factory cost = Direct material cost + Direct labour cost + Direct expenses + Production overheads*
* Production overheads include both fixed and variable production overheads.
Factory cost goes one step ahead from prime cost (direct costs) and therefore includes manufacturing overheads (indirect costs) as well. So, we can also say that:
Factory cost = Prime cost + Production overheads.
Factory cost concept is used to determine the gross profit that a cost unit (product or service) generates. It can help in pricing decisions as well. A business would ideally set the price above its factory cost so that it provides cover for non-production overheads (admin expenses) and generates profits for the organization.
Every business aims to maximize its profits and for that, it needs to minimize its costs. Total costs are broken down into different components for microscopic view and analysis. The concept of factory cost enables the management of a business to have a detailed look into all the factory costs which include direct costs (prime costs) as well as indirect costs (production overheads). Idea is to find any room for cost cutting so that the product or service becomes more profitable.
Example of factory cost
Factory costs of a furniture manufacturer may include:
- direct material costs such as wood, plastic etc.
- direct labor costs such as wages of persons making furniture from wood and plastic.
- direct expense such as royalty paid for each item produced to another company whose design or brand is used.
- manufacturing overheads such as factory rent, heating and lighting, salary of Factory Supervisor, repair and maintenance of machinery etc.
Factory cost as a part of total cost
To sell a good or a service, a business has to incur some costs which include both:
- prime costs (direct costs), and
- overheads (indirect costs)
Here is a proforma cost card which shows the total costs of a product. Factory cost is highlighted to get a better idea where it fits in the full cost calculation of a product.
