How to Calculate Production Costs: Materials, Labor and Overhead

Production costs are the costs of making a product or delivering a job: direct materials, direct labor and manufacturing overhead. To calculate them for a batch or job, add the materials traced to it, the labor traced to it, and the share of overhead assigned to it. Divide the total by the number of units to get a cost per unit. OpenStax calls these product costs: "all expenses required to manufacture the product: direct materials, direct labor, and manufacturing overhead".

Billed publishes this page. Definitions are quoted from the open textbook OpenStax Principles of Accounting, Volume 2: Managerial Accounting (published February 14, 2019; pages revised April 23, 2026), opened on October 30, 2026.

The three parts

• Direct materials: OpenStax says: "Direct materials are the components used in the production process whose costs can be identified on a per item-produced basis."
• Direct labor: OpenStax says: "Direct labor represents production labor costs that can be identified on a per item-produced basis." It adds: "The direct labor cost would be the amount of labor in hours multiplied by the hourly labor cost." For what goes into the hourly cost and how to tell direct from indirect labor, see what is direct labor cost and indirect labor cost.
• Manufacturing overhead: the production costs that can't be traced to one unit. OpenStax's examples: "Examples include the department manager’s salary, the production factory’s utilities, or glue used to attach rubber molding in the auto production process." For the definition and how to work out an overhead rate, see what is overhead cost.

How overhead reaches a product

Overhead can't be traced to each unit, so it's assigned. OpenStax says: "Since there are so many possible costs that can be classified as manufacturing overhead, they tend to be grouped and then allocated in a predetermined manner to the production process." How businesses choose the allocation base is covered in what is cost accounting.

Costs that aren't production costs

Period costs are kept out of production costs. OpenStax says they're "treated as an expense in the period incurred", and its examples include "many sales and administrative expenses". Advertising and office salaries are two everyday examples of selling and administrative costs.

Sample: production cost of one batch

The figures here are a sample, invented for this example. A furniture workshop makes a batch of 40 chairs.

1. Direct materials: wood and fabric of $45.00 per chair, so 40 × $45.00 = $1,800.00.
2. Direct labor: 1.5 hours per chair at an hourly labor cost of $28.00 (wages, payroll taxes and benefits), so 40 × 1.5 × $28.00 = $1,680.00.
3. Manufacturing overhead assigned to the batch: glue and nails $40.00, the supervisor's time $350.00 and workshop utilities $250.00, so $40.00 + $350.00 + $250.00 = $640.00.
4. Production cost of the batch: $1,800.00 + $1,680.00 + $640.00 = $4,120.00.
5. Cost per chair: $4,120.00 ÷ 40 = $103.00.

The workshop's showroom rent and advertising aren't in this total; they're period costs.

Where Billed fits

Billed's expense tracking page says: "An expense in Billed records who you paid, when, how much and which category it belongs to, with the receipt attached to the same entry." Recording materials, labor and overhead costs in separate categories makes each part of the total easier to find. Ask your accountant how to group your costs.

Related Articles

• What Is Direct Labor Cost?
• Indirect Labor Cost: How to Calculate It
• What Is Cost Accounting?
• What Is Overhead Cost?
• What Is Cost of Goods Sold (COGS) and How to Calculate It?
• How to Calculate Manufacturing Overhead Costs?
• What Are Net Sales? How to Calculate Them

Frequently Asked Questions

What are production costs?

The costs of making a product: direct materials, direct labor and manufacturing overhead. OpenStax defines product costs as "all expenses required to manufacture the product: direct materials, direct labor, and manufacturing overhead".

How do you calculate production cost per unit?

Add the direct materials, direct labor and overhead assigned to a batch, then divide by the number of units. In this page's sample, $4,120.00 for 40 chairs is $103.00 per chair.

How is direct labor cost calculated?

OpenStax says: "The direct labor cost would be the amount of labor in hours multiplied by the hourly labor cost."

What is included in manufacturing overhead?

Production costs that can't be traced to one unit. OpenStax gives examples such as "the department manager’s salary, the production factory’s utilities, or glue used to attach rubber molding in the auto production process."

Are selling and administrative costs part of production costs?

Not in OpenStax's terms. Its examples of period costs include "many sales and administrative expenses", and period costs are "treated as an expense in the period incurred".