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What are the three types of COGS?

Published in Cost Accounting 2 mins read

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:

  • 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.
  • 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.
  • 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.

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.