Manufacturing costs are the costs necessary to convert raw materials into products. All manufacturing costs must be attached to the units produced for external financial reporting under US GAAP. The resulting unit costs are used for inventory valuation on the balance sheet and for the calculation of the cost of goods sold on the income statement.

Manufacturing costs are typically divided into three categories...

1. Direct materials. This is the cost of the materials which become part of the finished product. For example, the cost of wood is a direct material in the manufacture of wooden furniture.


2. Direct labor. This is the cost of the wages of the individuals who are physically involved in converting raw materials into a finished product. For example, the wages of the person cutting wood into the specified lengths and the wages of the assemblers are direct labor costs in a furniture factory.


3. Factory overhead or manufacturing overhead. Factory overhead refers to all other costs incurred in the manufacturing activity which cannot be directly traced to physical units in an economically feasible way. The wages of the person who inspects the completed furniture and the depreciation on the factory equipment are part of the factory overhead costs. Factory overhead is also described as indirect manufacturing costs.

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