Commonly Used Classifications of Manufacturing Costs

Three terms commonly used when describing manufacturing costs are direct materials costs, direct manufacturing labor costs, and indirect manufacturing costs. These terms build on the direct versus indirect cost distinction we described earlier, applied to the context of manufacturing costs.

1. Direct materials costs are the acquisition costs of all materials that eventually become part of the cost object (work in process and then finished goods); they can easily and unambiguously be traced to the cost object. The steel and tires used to make the Tesla Model 3 and the computer chips used to make cellular phones are examples of direct material costs. Note that direct materials costs include not only the cost of the materials themselves, but the freight-in (inward delivery) charges, sales taxes, and customs duties that must be paid to acquire them.
2. Direct manufacturing labor costs include the compensation of all manufacturing labor that can easily and unambiguously be traced to the cost object (work in process and then finished goods). Examples include wages and fringe benefits paid to machine operators and assembly-line workers who convert direct materials into finished goods.
3. Indirect manufacturing costs are all manufacturing costs that are related to the cost object (work in process and then finished goods), but that cannot easily and unambiguously be traced to the cost object. Examples include indirect materials such as lubricants, indirect manufacturing labor such as plant maintenance and cleaning labor, plant rent, plant insurance, property taxes on the plant, plant depreciation, and the compensation of plant managers. This cost category is also referred to as manufacturing overhead costs or factory overhead costs. We use indirect manufacturing costs and manufacturing overhead costs interchangeably in this text.

We now describe the distinction between inventoriable costs and period costs.