Product costing for factories: materials, overhead and FIFO batches

Product costing for factories means working out what one good unit really costs to make: the raw material actually consumed, packaging, energy, labour and a fair share of the overhead that keeps the plant running. Done properly, it tells you which products make money and which ones only look as if they do. This guide walks through a worked example in rupees, compares FIFO with weighted average, and shows how to keep cost figures trustworthy month after month.

1What goes into the cost of one unit?

Start with the raw material actually consumed, including what is lost as scrap. Add packaging, electricity or fuel used by the line, direct labour, and a share of the overhead that keeps the plant running, such as rent, supervision and maintenance.

2Why do scrap and yield matter?

Cost per good unit rises as scrap rises. Recording consumption and scrap per shift, machine and product variant shows where the money is leaking, instead of averaging it away across the month.

3What is FIFO batch costing?

Raw materials arrive in batches at different prices. FIFO consumes the oldest batch first, so each production run is costed at the price of the batch actually used, and closing stock stays valued at recent purchase prices. When material prices move, your cost price moves with them instead of lagging behind.

4A worked example in rupees

The figures below are illustrative. A factory holds two batches of the same raw material and runs one production order:

• Batch A: 1,000 kg bought at Rs 200 a kg.
• Batch B: 1,000 kg bought later at Rs 240 a kg.
• The run consumes 1,200 kg, including scrap, and produces 1,000 good cartons.
• Packaging is Rs 30 a carton; electricity for the run is Rs 18,000; direct labour is Rs 40,000.
• The month's overhead is Rs 600,000 across 10,000 cartons, so Rs 60 a carton.

Both methods are acceptable under IAS 2. They give different answers when prices are moving: FIFO costs this run at the cheaper batch actually used and values the remaining stock at the newer price; weighted average smooths the two. What matters is choosing one method, applying it every month, and knowing which one your selling prices are based on.

5How should monthly overhead be allocated?

Overhead is usually known only after the month ends. Divide the month’s total overhead by the units produced, add it to the per-unit materials and energy cost, and refresh the cost price of each variant. Selling prices can then be checked against a margin you can trust.

Choosing an allocation base

6How do you handle by-products and waste?

Some processes yield more than one output, or material that can be reused. Decide a rule up front: either value the by-product and reduce the main product’s cost by that amount, or treat it as scrap with no value. Whichever you choose, apply it the same way every month so cost trends stay comparable.

7What mistakes make costs unreliable?

• Using one average purchase price for all of the year’s material.
• Ignoring scrap, so the cost per good unit looks lower than it is.
• Leaving out electricity, fuel or packaging because they are billed separately.
• Allocating overhead by guesswork instead of by units produced or machine hours.
• Updating selling prices only once a year, after the margin has already gone.

8How often should you review product cost?

Refresh cost prices at least monthly, as soon as overhead is known, and again whenever a major input price moves. A short monthly review of the five products that make up most of your sales is worth more than a perfect annual exercise.

Compare standard cost (what the product should cost) with actual cost (what it did cost) and investigate the difference. That gap is where improvements are found.

A variance you can act on

Suppose the standard cost of a carton is Rs 380 and the actual cost this month is Rs 396. The Rs 16 gap breaks down into parts you can investigate: material price (the newer batch cost more), material usage (scrap was higher than standard), and overhead (fewer units than planned to share the fixed costs). Each part points to a different person: purchasing, the production supervisor, or planning.

9What a costing sheet should hold

Whether it is a spreadsheet or a system, every costing record needs:

• The production order, product variant, shift and machine.
• Raw material batches consumed, with quantity and batch price.
• Good output and scrap, in the same unit.
• Packaging and consumables used.
• Energy and direct labour for the run.
• The overhead rate applied, and the base it was applied on.
• The resulting cost per good unit, dated.

10Turning cost into a price decision

A cost figure is only useful if it changes what you do. Each month, list your products with their selling price, current cost per unit and margin, sorted by sales volume. Three questions usually follow:

1. Which products fell below your target margin this month? Check whether the cause is a material price, a usage problem or under-used capacity before you raise the price.
2. Which customers buy mostly low-margin products? A client ledger next to the cost data shows this without a separate report.
3. What happens to cost if volume drops by a fifth? Fixed overhead spread over fewer units can turn a profitable product into a loss-maker.

11Keep production, stock and the ledger in step

If the floor logs production in one tool, stock sits in another and the accountant keys journals later, costs drift apart. A dispatch should do three things at once: reduce finished-goods stock, update the client’s ledger and post a balanced journal entry. That is how Batchbook is designed: enter it once, and every book balances. Its QR code gate pass system does exactly this for every dispatch. If your costing method is different from the standard, we build it as accounting and costing software around the way your factory works.