Calculate a Product Cost in Just 5 Steps

Welcome to this chapter on the art and manner of calculating a cost price!

In this Operational Management course, we will see in this chapter on cost analysis the 5 steps that must be mastered to calculate a cost price.

Concretely, here are the different steps to follow that I will cover in this article:

1. Determine the costs to be taken into account to calculate a cost price
2. Define the manufacturing steps
3. Properly integrate direct and indirect costs
4. Calculating a cost price: Full cost method
5. Calculate the cost price
6. Conclusion

 

Step 1: Determine the costs to be taken into account to calculate a cost price

In a company there are a multitude of expenses. This is also the reason why several categories of expenses are possible.

In the course on exploitation analysis, I will show you a first distinction between operating expenses, financial expenses and exceptional expenses.

But to calculate a cost price, we need to distinguish between the direct charges and indirect charges.

Direct costs are directly attributable to a product without ambiguity because they are incurred only in the manufacture of this product. : production costs, marketing, sales commissions, etc.

Conversely, indirect costs are not directly linked to the operation of a product: reception service salary, parking rent, etc.

 

Step 2: Define the manufacturing steps

To calculate the full cost price of a product, it is necessary to understand the product manufacturing process.

First, the business unit purchases the raw materials and these are then stored. These first two steps form the cost of purchasing raw materials.

Step number 3 is to transform raw materials into finished products. This transformation generates production costs.

The cost of purchasing raw materials added to production costs makes it possible to find the cost of production of products sold.

The next step is to store the finished products.

Finally, the last step is the sale of finished products which generates distribution charges and non-production cost.

Here is a summary diagram of the manufacturing process to calculate a cost price.

Please note:

Of course, in a commercial enterprise, the storage steps are not included in the manufacturing process. This therefore also implies the absence of the production cost and the non-production cost.

 

Step 3: Properly integrate direct and indirect costs

Direct and indirect costs are gradually integrated into the cost calculation stages.

To calculate the cost of purchasing materials purchased, you must take the direct purchasing costs which correspond to the purchases and add them to the indirect purchasing costs (=supply).

To determine the cost of production of manufactured products, you must take into account direct production costs and add them to indirect production costs.

In order to find the cost of distribution of products sold, you must take into account the direct distribution costs and add them to the indirect distribution costs.

 

Step 4: Calculate a cost price: Full cost method

In this step No. 4, while answering the various questions, I will take a concrete numerical example so that the sequence of calculations is clearer for you.

Statement No. 1

The Casdeau business unit specializes in the design and sale of clothing, particularly trendy pants. To manufacture its products, it uses an MP raw material. The manufacturing process is as follows: passage through two workshops (AT1 and AT2), packaging workshop and then marketing. The manager Mr. Lepique sends you the following information for year N:

• PM purchases: 50 kg at €000;
• Production: 22 pairs of pants;
• Packaging: 19;
• Machine hours used: 11 hours;
• Sales: 18 pairs of pants.

How to fill out an indirect cost distribution table?

Here is the top of the basic table that is given in the appendix. This is the table to be completed by replacing the percentages with amounts. These are calculated using the values ​​of the two auxiliary centers to be distributed: Energy and Machine Management.

By doing this first work, you calculate the secondary distribution since you are starting from a primary totals basis.

Now here are the results after applying the percentages. The first line of the result corresponds to the distribution of the Energy center.

 

Calculations:

For 944: 11 x 800

For 2: 124 x 11

And the calculation principle is the same for the Machine Distribution center.

For 2: 280 x 38

For 10: 640 x 38

And so on…

You will notice that we have a “Total” line per main center: this is the “Total secondary distribution” line.

For example: 12 = 404 + 8 + 000

 

How to calculate the unit cost of an auxiliary center?

To calculate the unit cost of work, you must fill in the bottom of the distribution table taking into account the work units which are given.

To complete these last two lines, it is first necessary to determine the number of work units for each center.

The work unit is the unit of measurement of the activity of the center considered. It can be expressed in hours of work, in quantity purchased, in quantity sold, in thousand turnover…

To determine the number of work units in the “Supply” center, you must ask yourself the following question: “How many times do I have €1 in my total purchases?”

It is therefore necessary to calculate the total amount of purchases. To do this, simply apply the following formula: quantity x unit price

Which gives: 50 kg x €000 or €0,60.

Finally, to answer the question we apply a division: €30 / €000 = 1 work units for the “Supplies” center.

 

To determine the number of work units of the AT1 center, you must ask yourself the following question: “How many machine hours are used for the AT1 center?”

To answer this question, simply read the statement, i.e. 11 hours. There are therefore 000 work units for the AT11 center.

 

To determine the number of work units for the AT2 center, you must ask yourself the following question: “How many pants are manufactured in the AT2 center?”.

Again the answer is in the statement. There are 22 pairs of trousers produced. So there are 000 units of work in the AT22 center.

 

To determine the number of work units for the packaging center, you must ask yourself the following question: “How many pants are packaged in the Packaging center?”.

Again the answer is in the statement. There are 29 pairs of pants packaged. So there are 000 units of work in the Packaging center.

 

To find the number of work units in the Distribution center, you need to ask yourself the following question: "How many pants are sold?"

Here again the answer is in the statement. There are 18 pairs of pants sold. So there are 000 units of work in the Distribution center.

Here is the summary of all the calculations:

To calculate the unit cost of work, simply divide the total of the secondary distribution of the center by the number of units of work of the same center.

So for 0,41, the calculation is as follows: 12 / 404

For 3, the calculation is: 452 / 37

And so on…

 

Statement No. 2

The Caslamar business unit buys and sells spare parts for kitchens for large restaurants and other catering professionals. It would like to know the cost price of a new model that it wants to put on the market very soon. The Caslamar manager gives you several indications in order to answer the different questions:

 

• Purchases: 500 pieces at €100
• Sales: 620 pieces at €195
• Stocks at the start of the period: 160 pieces at €140
• Number of work units (“Supply” center): 500
• Number of work units (“Distribution” center): 1
• Cost of the unit of work: €21 (“Supply” center) and €12 (“Distribution” center)
• Supply costs: €3 per piece
• Distribution costs: €12 per item sold

 

How to calculate the purchase cost?

The chefentreprise.com website provides a definition of purchase cost very complete and very relevant.

To calculate the cost of purchasing spare parts, you need to design a table and take into account direct and indirect purchasing costs.

In this exercise, the Supply center represents indirect purchasing costs.

So here are the elements of the purchase cost:

The total purchase cost €61 is the sum of the amounts in the column.

The purchase cost quantity is not the sum of the column. It corresponds to the quantity purchased specified in the statement.

The unit price of the purchase cost is never the column total. It corresponds to the result of the division between the purchase cost amount and the purchase cost quantity (61 / 000).

 

How to fill out a stock sheet?

This is how the structure of a stock sheet looks like in this type of exercise:

In this stock sheet, you must indicate the entries and exits.

The entries on the left correspond to the stock of spare parts that the company has at the beginning of the reference period. You must also indicate the purchases of spare parts for the period.

In the outputs, you must indicate the final stock by deduction.

You must also indicate the quantity sold of spare parts estimated at the weighted average unit cost (WAUC).

This is how the stock sheet looks with the encrypted elements:

And here are all the explanations:

The initial stock is provided in the statement as well as the entries since they correspond to the purchases of the period.

The quantity output corresponds to the sales of the periodThe unit price of the outputs corresponds to the CMUP calculated on the Total line on the “Entry” side.

If you have a memory lapse for the calculation of the CMUP, I invite you to read my article on Inventory Management: The 7 Key Points to Master.

To find the ending stock, you need to take the difference between the total quantities  input side and output quantity.

We therefore have the following calculation: 660 – 620 = 40 for the final stock in quantity. The calculation method is identical for the value of the final stock.

We therefore have the following calculation: 83 – 400 = 78 for the final stock in value.

 

How to calculate the distribution cost?

To calculate the distribution cost, you also need to make a table with the following frame:

To complete this table, you must indicate the direct distribution costs and the indirect distribution costs.

It should not be forgotten that the centers are often the indirect costs.

So here is the distribution cost in figures:

There is not much to say about the calculations because all the elements are given in the statement.

Regarding the “Distribution Cost” line:

You do not have to add up the quantity column to get the total. You have to read the statement and find the quantity sold during the reference period. On the other hand, it is the sum of the Amount column which gives the total amount of €26.

The unit price of the distribution cost is equal to the division between the total amount and the total quantity. We therefore have the following calculation: 26 / 640 = 620. You should never add up the column because that would make no sense!

 

Step 5: Calculate the cost price

To calculate a cost price, you must use the same framework as before:

It is a question of making the "sum" between the purchase cost of parts sold and the distribution cost. The cost of purchasing the parts sold corresponds to the stock output of spare parts calculated at CMUP.

Again, you do not need to add up the quantity column or the unit price column for that matter to find the totals.

Only the amount column is totaled to obtain the cost price in value. The total quantity corresponds to the sales made. The unit cost price corresponds to the division between the total amount and the total quantity.

 

Conclusion

In this article, we have seen the 5 steps to follow to calculate a cost price. This is work that requires great rigor because you often have many elements in the statement.

By following these steps strictly, you will have no trouble finding the requested cost price.

If you want to practice with corrected exercises on cost price then don't hesitate to read my article Cost price: 3 Corrected exercises.

There you have it, now you know how to calculate a cost price. You no longer have any excuses for not reaching your goal: Get an excellent grade in the Operational Management test!