Factory cost, also known as manufacturing cost, refers to the total cost incurred to convert raw materials into a finished product in a manufacturing environment. It encompasses all the costs that are directly associated with the production process, as well as indirect costs, or overheads, that support the production environment.
Factory cost is typically composed of three elements:
- Direct Materials: These are the raw materials that become a part of the finished product. For example, in a bicycle manufacturing company, the cost of metal used to make the bike frame, the cost of tires, chains, seats, etc., would be included under direct materials.
- Direct Labor: These are the wages paid to the workers who directly work on the product being manufactured. For the bicycle manufacturer, this would include wages paid to workers who assemble the bikes.
- Manufacturing Overhead: This includes all the indirect costs associated with manufacturing the product. For the bicycle manufacturer, this could include depreciation on factory equipment, utilities for the factory, factory supervisor salaries, maintenance costs, and more. These costs are not tied directly to a specific unit of production, but they support the overall production process.
Together, these components give you the total factory cost or manufacturing cost. This cost is crucial for determining the cost of goods manufactured, which is then used to calculate the cost of goods sold and gross margin on the financial statements. It also aids in pricing decisions and profitability analysis.
Example of Factory Cost
Suppose a company called “ChairCraft” manufactures wooden chairs. Here’s how the factory cost might break down:
- Direct Materials: ChairCraft purchases wood, nails, and glue for the production of each chair. If the raw materials cost for each chair is $20, this is the direct material cost.
- Direct Labor: The workers at ChairCraft are paid $15 per hour. It takes one hour to assemble each chair, so the direct labor cost per chair is $15.
- Manufacturing Overhead: ChairCraft has a number of indirect costs associated with manufacturing. These include:
- Depreciation on factory equipment: $5,000 per year
- Factory utilities: $1,000 per month, or $12,000 per year
- Factory supervisor salary: $60,000 per year
- Maintenance costs: $2,000 per year
Adding these three elements together, the total factory cost per chair is:
- Direct Materials: $20
- Direct Labor: $15
- Manufacturing Overhead: $7.90
Total Factory Cost per Chair = $20 + $15 + $7.90 = $42.90
So, according to these calculations, it costs ChairCraft $42.90 to manufacture each wooden chair in its factory. This is the factory cost for each chair.