Thursday 12/27/2018

Manufacturing Costs: Is the price of the product right?

Akta Parikh, CPA, CA is a senior associate at Corrigan Krause. 

The most important decision after deciding when, where and what to sell, is at what price. It is common for manufactures to achieve strong top-line sales and still have a loss or less than desirable profits.

Today we will focus on product costing aspect. So, what are costs? An estimate of a price.

Costs to manufacture a product are known as manufacturing or direct costs. Some of the most common costs are raw materials and labor.

It is well known that raw materials are a direct cost. But what about the cost to have materials delivered to your location or the cost of storing that material? Similarly, for labor, the most common are wages for all employees who are on the floor. But what about the salary for a product designer? Or an owner? Or a manager who visits the floor or supervises the production process? To get a more accurate product cost, we have to allocate their salaries to inventory (i.e. product cost). Other costs that we often times fail to capture in production are utilities, depreciation, rent and quality control costs. Other uncommon costs are research costs, warranty costs, repair and maintenance related to equipment and packaging costs. All of these should be allocated to truly understand how your business operates and performs.

Allocation is assigning costs using various factors.  These factors are based on past experience and the industry in consideration. We won’t go into detail on how to allocate costs, but here is table for a manufacturer with more than one product.

Cost Allocations

Basis/Factors of Allocation

Material Material consumed per unit
Labor Labor hours, Machine hours, Units produced
Depreciation Machine hours
Utilities, packaging Units produced
Manufacturing overhead Units produced, labor or machine hours

 

Cost allocation is an important planning tool for understanding profitability and increasing profits. It is important to know each element of costs, as each cost helps in making various types of decisions. Such as, should we expand production of a certain line? Or should we run a third shift?

Remember each business is unique and there are more than the aforementioned costs and more methods of cost allocation. Before adopting any cost system consult your CPA at Corrigan Krause. We cater according to needs of your company and can directly assist you to find the right price for your product.

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