In order to work out the exact labour and wages costs to be attributed to each unit of production, an organisation must take a careful study of the production process and allocate the appropriate expenses. If, for example, an individual earns £10 per hour and processes 10 units during that hour, then £1 of direct costs may simply be added to each unit. Unfortunately, things are not that simple.
There are many other individual costs which an organisation must bear in the employment of individuals. These may include employer’s national insurance contributions, pension payments and insurance policy payments. In most organisations, labour and wage costs account for the majority of direct costs.
- Materials – the costs of materials differ according to the sector in which an organisation operates. As organisation that operates in the primary sector has comparatively low material costs. At the other end of the scale, in the tertiary sector, the costs of finished goods to a retailer for example, will be extremely high. The principal elements that affect the costs of materials should be included in the organisation's overall budgetary controls. In addition, an organisation must also consider the cost of materials in relation to market demands, as these will inevitably cause periodic fluctuations in material costs.
Only those materials that are actually used in the production of a product or service should be considered part of the cost of that product or service.
Task 2 Page 2
Other consumables used by the organisation are classed as indirect costs and are considered under separate budgets.
Indirect costs
(for Quirk, rent/rates, sales/ marketing/ insurance/ non-production depreciation management salaries)
Indirect costs are costs incurred in the running of an organisation that cannot be easily apportioned to the production process. In effect, they cover all of the support and management services of the organisation. These indirect costs may be apportioned in percentage terms to each unit produced. However, the optimum balance between direct and indirect costs can be somewhat difficult to ascertain. If an organisation allows its indirect costs to rise in a disproportionate manner to its direct costs and production levels, then we can consider the organisation to be rather ‘top heavy’. It will suffer loss of both profit and working capital.
The main forms of indirect cost are:
- Other wages
- Depreciation
- Management
- Administration
- Marketing
- General running expenses
