What a manufactured item actually costs

A manufactured item has a cost that nobody invoiced. It is assembled from several facts - materials consumed, time worked, machines run, a share of the factory - and each one arrives from a different place at a different time. Which is why the number is so often wrong, and so rarely known to be wrong.

Start from the recipe, then measure the difference

A bill of materials says what should have been consumed to produce one unit. The work order records what actually was. The gap between them is the single most useful number in a factory, and it is only available if both exist: a system that records only actual consumption cannot tell you whether a batch went badly, and one that records only the standard cannot tell you anything at all.

Two refinements matter in practice. Yield - if a process reliably produces 95 units from materials for 100, the cost per good unit is higher than the recipe implies, and pretending otherwise understates every price you quote. And the base quantity: a recipe written per 100 units and applied to a batch of 7 must scale, and a rounding choice made there propagates into every cost downstream.

Labour belongs in the product, not beside it

This is the most common structural mistake. Wages for production staff get posted to a payroll expense account, the finished item is valued at material cost only, and the result is a product that looks cheaper than it is and a factory overhead account that grows every month with nothing to absorb it.

The consequence is not academic: your gross margin by product is wrong in a direction that makes low-labour and high-labour products look comparable when they are not. Pricing decisions made on that basis are systematically biased toward the products that are hardest to make.

Labour has to be attached to the work order and carried into the value of the output. The same is true of machine time and any directly attributable overhead.

Three things to get right about timing

• Consume at the cost in force when the material was issued, not at the cost today. A batch issued last month was made from last month materials.

• Value the output when it is completed, not when it is sold. Work in progress is an asset and belongs on the balance sheet while it exists.

• Return the leftovers. Materials issued and not used must go back to stock, or every future batch inherits the overstatement.

Variances are the point, not the paperwork

Once standard and actual both exist, the differences become readable: material variance says you used more than the recipe, price variance says the materials cost more than planned, labour variance says it took longer. Each points at a different decision and a different person.

A factory that reports a single total cost per batch has the data to produce these and is choosing not to. The variance is where the money is, because the total cost tells you what happened and the variance tells you why.

Assets, not expenses

One last trap with a disproportionate effect: durable items used in production - moulds, cylinders, tooling - are assets that depreciate, not purchases that expense. Booking them as purchase expenses in the month they are bought makes that month look terrible, every subsequent month look better than it is, and the balance sheet omit equipment you actually own.