 Hello, and welcome to the session in which you would look at the three basic manufacturing cost categories, direct material, direct labor and manufacturing overhead. These topics are covered in a miniaturial accounting course, cost accounting course, the CPA exam, and the CMA exam. So whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com, I don't replace your CPA review course if you're studying for your CPA. I am a useful addition. I can explain the material differently. I can provide you alternative explanation, alternative resource that's going to help you pass your CPA exam. Your risk is to try me for one month of subscription, your potential gain is actually passing the exam. And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other college courses as well. For example, this course is miniaturial accounting. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit. Let's go ahead and talk about the three basic manufacturing cost categories, direct material, direct labor and manufacturing overhead. The question is why do we need those three items? Well, the reason we need them. The need that is to cost something called a cost object. So that's another term you need to be familiar with. What is a cost object? What is a cost object? A cost object is anything for which a separate measurement of cost is desired. In other words, you are looking to accumulate cost and assign cost to a particular item. What that can item be? It could be anything. It could be a particular product line in your manufacturing facility. It could be a geographical territory. It could be a customer. For example, how much each customer is costing you to maintain that customer. For our purposes, we're going to be considering as cost object a pizza. We're going to be making cheese pizza and that's going to be our cost object. And based on this pizza, we're going to illustrate what is direct material, what's direct labor and manufacturing overhead. Now, obviously the example is simplified, but hopefully by understanding the three types of cost to manufacture, to make a pizza applies to any other concept. Starting with direct material. In your opinion, what material do we need to manufacture the pizza? Can you think of the material? Well, but let's see what's the general definition for direct material. Material that become an integral part of the product, a main part of the product. And here's the keyword. It can be conveniently traced directly to it. So you can easily see it. You can easily trace it, measure it, be aware of it. In your opinion, what could be the direct material for pizza? Well, I can see the sauce. I can see the cheese and I can see the dough. So I would say those three examples, by the way, the dough we purchased the dough, we did not make the dough, the sauce and the cheese. Is that the only three things? Maybe you might have something else. For example, this piece of mint here. We'll talk about that later. Okay, but those are the three main ingredient that goes into a pizza. Now, the reason I said the dough, we purchased the dough, we did not make the dough. Why? Because if we are making the dough, if we are making the dough, rather than purchasing the dough, the dough itself will be a cost object. What do I mean by this? Well, if we are making the dough, then remember the dough, we have to have flour to make the dough, eggs, we might add milk to it. I don't know, butter, whatever we need to make the dough. So the dough itself becomes a cost object for us, but we are not. We are not treating the dough as a cost object because we purchased it. We pay for it. We bought it as raw material, finished, ready to be processed into a pizza. Okay, so the point I'm trying to make here, a dough can be a cost object. A dough can be direct material, depending on the, what are we costing here? We are costing the pizza. We are not costing the dough. So make sure we are aware of this. Same thing that goes with the cheese. We are buying the cheese. Also, we can manufacture the cheese right from milk. The sauce, the same thing. We are buying the tomato sauce already finished. Okay, the product is a final product and we're putting all the product together. So this is what direct material is. And by the way, direct material is known as also direct cost. And what is a direct cost? A cost that can be conveniently traced directly to a product, direct cost. Hopefully you would remember, direct material, direct, direct cost. So make sure you're aware of that. Now let's talk about direct labor. What is direct labor? Well, here's the definition for it. Direct labor is also known as touch labor. Touch means a labor that's going to touch the product. Also, it should be easily traced to individual unit of product. The example, for example, for making the pizza, the chef themselves. The chef or the cook that's making the pizza is considered direct labor. Why? Because this individual is touching the product, is working on the product, is adding the sauce, adding the cheese, spreading the dough, taking the whole thing and putting it into the oven, taking it out of the oven, putting it into a box, getting the product ready. And this individual is directly involved in this process. So this is what direct labor is. They're directly involved and we can easily trace their effort to the product. Well, also direct labor is also considered direct cost. So notice direct material is direct cost, direct labor is direct cost. And by the way, I'm going to be abbreviating DM and DL for direct material and direct labor. Now, think about a pizzeria. Are these the only costs we are going to be incurred to make a pizza? Of course not. As you can see, we need the building here. We need utilities. We need the oven. We need utilities to run the oven. Maybe we need wood if it's for using fire. We need all sorts of different supplies, so on and so forth. So any cost that we incur other than direct material, other than direct material and direct labor in our manufacturing facility is called manufacturing overhead cost abbreviated as MOH. So what is the definition for manufacturing overhead? All other costs other than direct material and direct labor in the manufacturing process that cannot be readily and easily traced to the finished product. Again, we could have many other costs. What could be some other costs that cannot be easily traced? Well, let's take a look. We could have something called indirect labor. Hold on a second, didn't we talk about labor? Yes, we talked about direct labor. Here we are discussing indirect labor. So what would be an example of indirect labor in a pizzeria just for the sake of illustration? Well, let's take a look at this picture. Well, we have the manager here. This is indirect labor. The manager don't make the pizza. The manager supervises the process. We have the cashiers. The cashiers here, they don't make the product. They don't make the product. All what they're doing is they're helping sell the product, they're not selling it, helping in the process. Let's assume this is the cook. If this is the cook, this is a direct labor. So indirect labor could be we might have a security guard at that restaurant. Well, that's indirect labor. Yes, they are labor, but they're not making the product. We could have a janitor at that restaurant. They are a part of the cost, but they're not considered direct labor. They're indirect labor. And indirect labor is considered manufacturing overhead. We could also have indirect material. Again, a type of material, but it's indirect. It cannot be easily traced. Let's go back to the pizza. It's a possibility that we could add a little bit of salt to that pizza before we bake it for taste. How much do we add salt on that pizza? It's not worth keeping track of that salt. Maybe a little bit of salt, half a spoon of salt, a spoon of salt. That's not worth keeping track of. Also notice here, we add this piece of mint on the pizza. It is part of the cost, but this is a small piece of a mint. So yes, we purchase the mint, but it's not worth keeping track of that mint separately for each unit of pizza. Therefore, these are considered manufacturing overhead for manufacturing the product. Also, we could have many other manufacturing overhead. Depreciation of manufacturing equipment. Be careful, because on the CPA exam, they try to trick you. They would say depreciation. Well, depreciation could be manufacturing overhead. It could be something other than manufacturing overhead. And we'll see what do we mean in a moment. Because here, the manufacturing overhead is any cost, any depreciation that deals with the equipment that we use in the manufacturing facility. So depreciation of manufacturing equipment, for example, the oven at the pizzeria. Utility cost to run the utilities. Property taxes on the building where we are operating. Insurance premium incurred to operate a manufacturing facility or a restaurant or for making a pizza. That's also part of the manufacturing overhead. Manufacturing overhead. Also know that manufacturing overhead is considered indirect cost. Why it's indirect cost? Because it cannot be easily traced to the finished goods. So we have to allocate this. And we're gonna talk about allocation later on. So make sure you know what is direct cost, which is direct material, direct labor, what's indirect cost, manufacturing overhead. Other terminology that you need to be familiar with when it comes to these terminology is, when we take direct material and direct labor, we call those prime cost, prime or the main cost. So to manufacture something, you need direct material and direct labor. Together we call them prime cost. Also, when we take direct labor and manufacturing overhead, those two together is called conversion cost. So labor and manufacturing overhead, they actually convert the cost into a finished goods. Just terms you need to be familiar with. You could be asked about on the exam, on the CPA exam, on the CMA exam. Those terms are standard. So you need to be aware of this. Now we talked about the three basic manufacturing cost. We need to understand that we have manufacturing cost. We have also non-manufacturing cost. It's very important to start to distinguish, to differentiate between these concept. Everything that we talked about was manufacturing cost. Manufacturing cost is a cost that's incurred in the actual manufacturing facility, in the actual production facility. For example, this picture here is for Croyola, where they make the crayons. This is manufacturing cost. This is where direct material, direct labor, and manufacturing overhead takes place. Now also, Croyola, the company that makes those crayons, also they have their own headquarter. And in this headquarter, you can, this is where the CEO's office, the CFO's office, HR, accounting, payroll, administrative, and support. This is non-manufacturing cost, because it's not part of the manufacturing facility. It is part of the cost, but it's not part of the manufacturing cost, okay? So what do we consider non-manufacturing cost? Well, we have basically two type, selling cost, which is cost necessary to secure the order and deliver the product. Selling cost can be either direct or indirect. Now let me go back to this picture here, because I think I kind of, I wanna clarify it or I misspoke. I would say the cashier, the cashiers are not part of making the pizza. The cashier, because they're selling the product, we're gonna consider it selling cost. But we're gonna assume that the manager here is supervising the production of the pizza, okay? So selling cost is non-manufacturing. Selling cost is non-manufacturing. Why? Because when you sell the cost, it's when you sell the product, when you pay salespeople to sell your product, the product has been manufactured. The manufacturing process is finished, okay? So cost necessary to secure the order, not to produce the product and deliver the product, okay? Selling cost can be either direct or indirect. So direct means for every product you sell, you incur a cost or it could be indirect. You could be renting a building to house your selling team. Also, we could have administrative cost that's not considered non-manufacturing cost. Again, we talked about administrative cost in a moment, executive, organizational, clerical cost. Again, administrative cost could be direct or could be indirect. It can be easily traced to something or not easily traced. Best way to illustrate this is to work an example. Which of the following is not true for direct and indirect cost? Let's start at the bottom. Direct cost can be easily traced to a particular cost object. Yes, that is true, which is out. The salary of factory manager, a factory manager would be classified under an indirect cost of producing one unit of product. Yes, the manager of the factory is considered indirect, indirect cost as part of the manufacturing overhead, which is true of the indirect cost. Depending on the cost object, a particular cost can be either direct or indirect. This looks interesting, let's look at A. Whether a particular cost is classified as direct or indirect does not depend on the cost object. So basically A and B, one of them is correct because when it says the cost object determine whether something is direct cost or indirect cost, so cost object. Let's talk about the example that we looked at earlier. We looked at the pizza and we say that the cheese was direct material in that pizza. When the pizza was a cost object, the cheese is direct material. Let's assume rather than we are manufacturing or we are making a pie of pizza, let's assume we are making a spaghetti. And guess what? On this spaghetti, when we serve the spaghetti, we ask the customer whether they want some cheese on their spaghetti. So we spray a little bit of cheese on the spaghetti. Under those circumstances, the cheese is indirect material. What do I mean by that? Indirect means indirect material means it's not conveniently keeping track of that little bit of cheese that that customer sprays on their spaghetti. Because now the spaghetti is the cost object. The plate of spaghetti is the cost object. The cheese is considered indirect cost or indirect material. So it does depend which cost object you are dealing with. So depending on the cost object, a particular cost can be direct, like in the cheese for the pizza, or indirect the same cheese for that plate of spaghetti. And here we are assuming that that individual doesn't like the cheese too much. If they like the cheese, let them get a white pizza, right? But the point here is they're getting a pizza with a sauce and adding a little bit of cheese on that pizza. So really it's not conveniently keeping track of that cheese because each customer will put a little bit of cheese. Therefore we'll treat the cheese as indirect cost, indirect cost. At the end of this recording, I'm gonna remind you whether you are an accounting student or a CPA candidate to take a look at my website farhatlectures.com. I don't replace your CPA review course. I can help you understand the material differently. Your CPA exam is a lifetime investment. Don't shortchange yourself. Good luck, study hard, and the CPA is worth it. Study hard, stay safe.