What is a Cost Sheet?
The cost sheet is a Statement comprising of all costs associated with the Production, Administration, Selling and Distribution departments.
Recording of the cost sheet comes with its Benefits and Limitations.
Let’s explore them.
- What is a Cost Sheet?
- Benefits of Cost Sheet
- Limitations of Costs Sheet
- What Comprises of Cost Sheet?
- Total Cost
- Different Categories of Costs
- Frequently Asked Questions
Benefits of Cost Sheet
- The cost Sheet helps to obtain an accurate record of the total cost of goods or services with regard to manufacturing a product or providing a service.
- Provides a detailed breakdown of each cost element involved in various departments.
- Assists in verifying if the costs at all levels are in line with the budgeted figures
- Serves as a good aid for arriving at the selling price of goods by adding the requisite profit margin.
- Assists the Management of entities to make informed decisions such as where efficiencies can be improved, cutting down the costs, adding automation and reducing Labor costs to improve productivity etc.
- Cash Management is one of the significant challenges in any industry (manufacturing or service). The cost sheet provides a good control of expected costs and profits. Thereby facilitating effective cash management
Limitations of Costs Sheet
- Maintaining Costs sheet can be a time-consuming and tedious process
- An adequate, Proficient Cost accounting team needs to record all the cost elements in this cost sheet
- Periodical reviews of the Costs sheet and check for data accuracy by running a comparison with historical data. This step needs a Competent team.
- Risk of inaccurate data feeding into the cost sheet due to the enormous volume of data
- Requires good coordination with the other cost departments, which could be challenging.
What Comprises of Cost Sheet?
The cost sheet Comprises the following Cost headers.
- Prime Cost
- Factory Cost
- Office Cost
- Total Cost
We need to break down these all-cost elements to gain a comprehensive understanding.
As the name suggests, these are the primary costs in producing goods or providing a service. So, these are crucial for the business.
The following costs fall under the head Prime cost.
- Direct Material
- Direct Labor
- Direct Expenses
We will try to understand these cost elements with a Practical Example.
Health Synergy is a Pharmaceutical Company that manufactures medicines. The Company produces Pain Killer Capsules (AXL Capsule) with 3 Ingredients – A, X and L.
The cost incurred for Purchasing the Raw Material (A, X and L), which is used in producing the finished goods (AXL Capsule), is called Direct Material. We call such Raw Materials a direct expense because those form the basis for the production of drugs.
Direct Material doesn’t just include the cost of raw material used in production.
There are other cost elements, such as carriage inward/outward charges, insurance expenses and normal Loss.
Why is Normal Loss part of Direct Material?
Let’s understand the reasoning.
Loss is possible because of spillage due to movement from Supplier to Factory, Factory to Plant and machinery unit or spillage. Some other examples are Loss of Goods in transit or physical damage. Transportation of Vegetables might result in some Damage or not be in saleable condition.
These Losses are unavoidable and might not be in the entity’s control. We term this Normal Loss and will be part of the Direct Material.
In other words, we count the cost paid for such normal Loss as part of Direct Material even if those are not part of producing the Finished goods.
Direct Labor is the wages paid to the Labor.
Let’s continue with the above example.
Drug Manufacturing might be an automatic process. But it does involve manual work. Machines can’t work on its own.
The Salaries paid to the workers/executives involved in the production process form part of the Direct Labor.
Other Cost elements of Direct Labor are incentives, overtime pay, bonuses etc.
Direct Expenses are the expenses that are directly attributable to the production. These include Royalty pay, power charges, and Lease charges for production equipment.
Business need incur every cost or expense for the finished good to exist. However, some expenses form the basis of production. Such costs are Direct expenses.
If there are any one-time expenses, then estimate its recoverable period or volume.
Let’s break down this.
How do we determine the Recoverable period?
If the expenses are incurred for “technical know-how,” the production team estimates these technical charges are incurred once every three years. So, these one-time fees are apportioned over the three useful years.
How do we determine the Recoverable Volume?
Let’s say a publishing company has to pay a fixed royalty charge to the owner of the book content. This royalty provides a right to publish and sell books for the next five years.
The publisher needs to estimate the number of books sold for the next five years and apportion the one-time royalty charges to each book/volume.
This apportionment helps to implement fair pricing in the cost sheet. Further, it doesn’t distort the annual costs of production. For example, higher costs in the first year and lesser costs in later years.
Now, we understood all the direct costs that form part of the prime costs.
Have you thought of what’s about the indirect costs?
We’ve it here. Those are also part of the costs sheet. But they fall under different cost categories.
These costs include prime costs and all factory overheads.
Let’s break down the factory overheads.
It includes indirect Material, indirect Labor and indirect expenses. We will learn all those cost elements in detail.
Indirect Material is not the primary raw Material used in the production. For example, Lubricants used in the Plant & Machinery.
There is a thin line to distinguish the Material as direct vs indirect.
Let’s assume a Furniture manufacturing business.
The entity produces a wooden chair with a beautiful design on its outer part. The Final output comes only after using the following inputs.
- Labor Charges
- Machinery to get a Flower design
- Wood Glue
Now, let’s see what is direct costs vs indirect costs here.
Wood is the direct cost. Wood Glue and Nails are also necessary for the outcome. But those are in small quantities when compared to the direct Material.
So, consider the need to merit such materials as direct.
The rule here is to check whether those materials are identifiable within the composition of the finished product.
Indirect Labor Costs
Indirect Labor Costs are also the labor costs relatable to production. For example, Wages paid to the purchase departments, go-down workers etc.
Indirect Expenses include factory building depreciation, repair and maintenance of factory machinery, service department costs, etc.
What are the other names of Factory costs?
We need to add the Opening balance of work in progress to the Gross Factory costs and deduct the closing balance of work in progress to obtain the Net Factory costs.
Office and Administrative Cost
It is the sum of the Factory and office and administrative costs.
Office and Administrative costs include the Salaries of the Finance team, building lease rentals, water charges, electricity expenses, and office supplies.
Total cost is the sum of the office cost and selling and distribution overheads. Selling and Distribution overhead costs include Marketing, Advertising, Digital Marketing expenses, Salaries, Wages and incentives of the marketing agents, commission for the agents, etc.
Different Categories of Costs
All the Cost elements discussed above can be either fixed or fluctuating. So, there are two categories of costs per their nature. Those are below
- Variable Costs
- Fixed Costs
Fixed costs are the ones that are Static and will not fluctuate with increased production units. Variable costs are quite the opposite. These costs vary based on number of units being produced. For example, consider two cost elements, Direct Material and Factory Rent, with respect to manufacturing Ceiling Fans. Ceiling Fans are available for sale at $70 per unit. The details of the cost elements in amounts are below.
- Direct Material = $30 per each unit
- Factory Rent = $20,000 per each month
Let’s understand the meaning of two cost components – Material and Rent. For each Ceiling Fan production, an entity need not pay extra Rent for the Lease of the Factory building. However, the entity must incur direct material costs for each of the Ceiling Fans produced. But costs like Factory rent will not keep changing for every production unit. That’s because Rent is a fixed expenditure and doesn’t increase with each increased production.
In other words, fixed costs per unit decreases for additional output. That’s because its a shareable expense with fixed amount.
Frequently Asked Questions
How do you calculate profit in the cost sheet?
The focus of preparing a cost sheet isn’t to arrive at a profit. The idea is to group all costs of production, Administrative and Selling overheads.
Thus, profit isn’t calculated in the cost sheet.
Instead of calculating profit, the business owner estimates the profit as a percentage of the total cost after studying industry trends, market factors and break-even sales points.
What is the formula of cost sheet?
Cost sheet is not a mathematical formula. That’s a structured format of recording the various costs elements involved in manufacturing goods.
What are the different types of cost sheet?
Cost sheet is a decision making tool. It helps to understand the different types of cost element at each stage of production.
There aren’t any different forms of cost sheet. The format discussed here is a standard one, which is widely accepted.
Cost sheets are an invaluable tool for businesses looking to accurately track their expenses and improve budget management. However, some potential drawbacks should be considered when utilizing this resource. Be sure you understand all potential advantages and limitations before creating your cost sheet so you can make informed decisions about how best to manage your Company’s finances!