Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

16.1.4 The Cost Breakdown Structure of a Product: Material and External Labor

Intended learning outcomes: Explain cost accumulation breakdown. Present in detail material costs and external labor costs.

The cost accumulation breakdown, or cost breakdown structure of a product, is the accumulation of manufacturing costs in various subdivisions of costs, or cost types, according to the product structure.

Figure shows an example cost accumulation breakdown for calculating the product costs. It is a break­down of costs used by a manufacturing company.

Fig.       Example cost accumulation structure, or cost breakdown structure of a product.

Material costs are the costs associated with purchased components.

Material costs are subdivided into two cost subtypes:

  • The variable material costs for a product are the sum of, firstly, the cost of purchased components (the true procurement costs), and, secondly, the variable material costs for all components produced in-house.

    Note: In many American costing systems, material costs also include the full cost of goods manufactured for components produced in-house (variable and fixed), rather than just the variable material costs (principle of the make-or-buy decision). In that case, the term component costs would be more appropriate than material costs (see the definition of the terms material and components in Section 1.1.1.
  • The fixed material costs comprise, firstly, the costs of supplier and component qualification, secondly, the purchasing costs, thirdly, the carrying costs, and fourthly, the costs of receiving and inspecting purchased goods.

    The simplest way to express fixed material costs is as a percentage by dividing the total fixed costs by the total turnover of goods with variable costs. This calculation is carried out at the end of a budget period, using the data for the period just ended. It serves as the forecast for the next period. It is possible to use different percentages as a function of the storage type (special packa­ging or buildings, refrigerators, etc.) or as a function of the type or value of the goods (such as iron, gold, wood). How­ever, the fixed costs must then be recorded separately for the various categories. The more exact and “fairly” costs should be allocated to products, the more expensive costing becomes. This also holds for activity-based costing (Section 16.4).

External labor costs are the costs associated with the subcontracting of work.

Work may be subcontracted because the necessary production techniques, infrastructure (special machines), or capacity are not available in-house. For financial accounting, special cost centers are defined for such operations. The ID used for the cost center may be the same as the supplier identification. External labor costs are further subdivided into two subtypes:

  • Variable external labor costs are the sum of all invoices arising from work subcontracted to suppliers, and they contain the suppliers’ fixed costs. For the subcontracting company, on the other hand, these costs are variable costs.
  • Fixed external labor costs are the various costs generated by the subcontracting of work, particularly cost of shipping and transporting goods to and from the supplier, cost of receiving and inspecting the goods processed by subcontractors, as well as administra­tive expenses associated with subcontracting work (evaluation, writing the order, and so on).

    Usually, fixed external costs are expressed as a percentage in relation to the total in­voiced amount for subcontracted work. We can apply different percentages to different categories of suppliers, in which case the fixed costs must be recorded separately for each category. As with material costs, the percentages are calculated at the end of a budget period and then serve as forecasts for the next budget period.

Continuation in next subsection (16.1.4b).

Course section 16.1: Subsections and their intended learning outcomes