The three primary types of Costs of Goods Sold (COGS) are direct materials, direct labor, and manufacturing overhead.
Here's a breakdown of each category:
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Direct Materials: These are the raw materials that are directly used in the production process and become an integral part of the finished product.
- Examples: Wood for furniture, fabric for clothing, components for electronics, or ingredients for food products.
- The cost includes the purchase price of the materials, freight charges, and any other directly attributable costs.
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Direct Labor: This refers to the wages and benefits paid to employees who are directly involved in the manufacturing or production of goods.
- Examples: Assembly line workers, machinists, painters, or any personnel that directly handle or transform the direct materials into finished goods.
- Only the labor directly contributing to production is included. Management salaries are generally excluded.
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Manufacturing Overhead: This encompasses all other costs incurred in the production process that are not direct materials or direct labor. It's often the most complex category.
- Examples:
- Indirect Labor: Salaries of factory supervisors, maintenance staff, and quality control personnel.
- Indirect Materials: Cleaning supplies, lubricants for machinery, and other materials not directly incorporated into the final product.
- Factory Rent & Utilities: Cost of renting the factory space and the utilities (electricity, water, gas) used in the production process.
- Depreciation: Depreciation expense on factory equipment and buildings.
- Factory Insurance: Premiums paid for insuring the factory and its equipment.
- Repairs and Maintenance: Costs associated with repairing and maintaining factory equipment.
- Examples:
Understanding these three types of COGS is essential for accurately calculating a company's profitability and making informed business decisions. Breaking down COGS helps identify areas where costs can be reduced and efficiency improved.