Product cost sheets for manufacturers: material, labour, overheads and why the books disagree

Owners of engineering units in Satpur and Ambad often describe the same difficulty. The costing shows a margin of eight per cent on a part, while the accounts for the year show a loss. In most cases neither figure is wrong. The two documents answer different questions, and no reconciliation between them has been prepared.

The article is written for owners, plant heads and finance managers who fix prices from a cost sheet. It covers the build-up of material, labour and overheads under AS 2, Ind AS 2 and the Cost Accounting Standards, and the cost records that section 148 of the Companies Act requires of notified companies. Law and practice are stated as at 1 October 2026; a labour rate fixed before the Labour Codes took effect on 21 November 2025 needs revision. The money at stake is the price itself. A sheet that understates material, or spreads overheads on actual output, produces quotations below cost and price rises in slow months.

The final sections show how the sheet is reconciled with the books each month, so that management can rely on both.

1. What a product cost sheet is for

A cost sheet states the cost of making one unit of a product, element by element. In a manufacturing group it serves four purposes at the same time:

• Pricing. OEM negotiations, annual price-downs, raw-material escalation claims and new-part quotations all begin with it.
• Product decisions. It shows which parts to keep, which to give to a job worker, and which line should receive the next machine.
• Inventory valuation. The cost of work-in-progress and finished goods in the financial statements is drawn from the same build-up, adjusted to the accounting standard.
• Compliance. Companies covered by section 148 of the Companies Act must keep cost records in a set format. Banks and stock auditors also ask for cost-based valuations.

When a cost sheet is maintained for only one of these purposes, usually pricing, it gradually moves away from the others, and that gap is the source of most later disputes.

2. Material: the largest number, and the one most often understated

Material often makes up 55–70% of factory cost in engineering, auto components and electrical goods. An error of a few per cent here outweighs every other element.

Gross weight, not finished weight. The casting, forging or bar is costed at its weight as bought. Scrap that comes back is then deducted at its realisable value. A 2.4 kg casting machined to 2.1 kg leaves 0.3 kg of borings, which have some value, although only a fraction of the input price.

Normal rejection and process loss. If 2% of castings are rejected during machining, that loss is carried by the good parts, so net material cost is divided by 0.98. Loss above the agreed norm is abnormal. It is charged to the profit and loss account and should be reported there as a loss.

Bought-out items. Seals, fasteners, bearings and packing material are easily missed or priced at an outdated rate. They should be taken from the bill of materials (BOM).

Inward costs. Material cost includes freight, unloading and inspection on incoming goods. CAS-6, the cost accounting standard on material cost, includes the costs of bringing material to its present location, and the inventory standards do the same.

GST. Material is costed net of input tax credit. Credit that cannot be taken is a real cost and belongs in the sheet, whether it is blocked, reversed, or lost when a supplier failed to file. The companion article on ITC for manufacturers covers this in more detail.

Price basis. The sheet may use the latest purchase price, a weighted average or a standard rate. Whichever basis is chosen should be recorded in writing. A quotation priced at last year's casting rate passes the increase to the customer at no charge.

3. Labour: the fully loaded hourly rate

A frequent error is to divide an operator's monthly wage by 208 hours. Both parts of that fraction are wrong, and the true rate is higher.

Above the line: the full cost of employing the person. This includes the employer's PF and ESI contributions, bonus, leave with wages and gratuity. Canteen and uniforms are added, together with any margin paid to a contract labour agency.

Underneath: effective hours. Holidays, leave and training are deducted from paid hours, as are shift handover, tea breaks and waiting time. Effective hours are often 80–85% of paid hours.

The four Labour Codes came into force on 21 November 2025. Under the Code on Wages, where allowances excluded from "wages" exceed 50% of total remuneration, the excess is treated as wages. Many factories will see higher PF, gratuity and leave costs as a result. A labour rate last revised before that date should be revised.

CAS-7, the standard on employee cost, applies the same logic. Employee cost covers all benefits, and idle time above the normal level is kept out of product cost.

4. Overheads: the capacity question

Two accountants, both working honestly, can reach very different product costs from the same overheads. The method chosen matters more than the arithmetic.

Machine-hour rates for machine-paced work. In a CNC or VMC cell, most conversion cost follows machine time. Depreciation, power and tooling fall in this group, as do maintenance and coolant. These costs are collected for the cell and divided by machine hours to give a machine-hour rate. Each product is then charged by its cycle time.

Labour-hour or another base for the rest. Supervision, quality control, stores, production planning and factory administration may be spread on direct labour hours or on another fair base.

Normal capacity, not actual output. No rule in this article matters more. Under AS 2 and Ind AS 2, fixed production overheads are allocated on the basis of the normal capacity of the facilities. In a period of low production the amount per unit stays the same, and the unallocated part is charged to the profit and loss account as an expense. CAS-2 explains how normal capacity is measured: the production achievable on average over several periods, after allowing for planned maintenance and normal stoppages.

As a result, a good month and a bad month produce the same product cost. The bad month carries an extra line, under-absorbed overhead, which measures the cost of idle capacity.

What stays out of factory cost. Under the accounting standards, inventory cost excludes administration unrelated to production, and selling costs. Finance costs and abnormal wastage are also excluded. These items should sit below factory cost in the sheet, where pricing can see them and inventory valuation leaves them out. ICDS II, which applies for income-tax purposes, follows broadly the same lines. It is notified under section 276(2) of the Income-tax Act 2025 (section 145(2) of the 1961 Act).

5. A worked example: a pump housing from Satpur

The figures are illustrative. No real business is described.

An engineering company in Satpur MIDC machines and assembles a pump housing for an OEM. Its normal output is 10,000 units a month, and the selling price is ₹680 per unit.

Machine-hour rate for the CNC cell. The cell has six machines working two eight-hour shifts for 300 days, at 85% normal utilisation: 6 × 16 × 300 × 0.85 = 24,480 machine hours a year. Annual cell overheads (depreciation, power, tooling, maintenance) come to ₹1,44,00,000. The rate is ₹1,44,00,000 ÷ 24,480 = ₹588 per machine hour.

Fully loaded labour rate. After employer contributions, bonus, gratuity, leave and idle time, the rate is ₹360 per effective hour.

The cost sheet, per unit:

What actually happened in October. Demand fell, and the company made and sold only 7,200 units. Castings cost ₹118 per kg against ₹110. Rejection also rose, so consumption reached 2.52 kg per good unit against the standard of 2.45 kg (2.4 kg grossed up for 2% rejection). The books for the month show a loss, while the cost sheet showed ₹59 a unit. The bridge between them is as follows:

(For simplicity, production equals sales, so the bridge has no stock movement, and all other costs ran at the cost sheet's rates.)

Each line of the table tells something different. At normal volume the product remains sound at a factory cost of ₹583. The losses came from idle capacity (₹3.5 lakh) and from a casting price increase that was never passed on (₹1.45 lakh). A rejection problem on the shop floor added ₹0.55 lakh. Each of these is a separate discussion, with sales, purchase and production respectively. If the cell's ₹12,00,000 had simply been divided by October's 7,200 units, machine overhead would have risen from ₹118 to about ₹167 a unit and factory cost to about ₹632. The three problems would then have merged into one higher "cost", which sales would have tried to pass on.

6. Why the cost sheet and the books disagree

Reconciling items belong to a small number of families. In most factories the same ones recur each year.

• Under- or over-absorbed overheads. The difference between overhead charged to products at normal capacity and overhead actually incurred.
• Variances. Material price and usage, and labour rate and efficiency, where the sheet uses standards.
• Items only in the financial accounts. Interest, bank charges, donations, provisions for doubtful debts, losses on sale of assets, prior-period items, tax.
• Items only in the cost records. Some cost systems carry notional charges, such as interest on capital employed, and these are reversed in the bridge.
• Inventory valuation differences. Stock may be valued at standard in the cost records, while the financial statements use the lower of cost and net realisable value under AS 2 or Ind AS 2.
• Depreciation differences. A cost sheet may apply a technical life to a machine, whereas the books follow Schedule II to the Companies Act.

A monthly reconciliation of this kind is the most practical test of a costing system. If one cannot be prepared, neither figure is safe to use in a price negotiation.

7. Cost records under section 148 of the Companies Act

Section 148 allows the Central Government to require specified classes of companies that produce goods or provide services to keep cost records. Above higher thresholds, those records must also be audited.

Who must keep cost records. Rule 3 of the Companies (Cost Records and Audit) Rules 2014 lists the regulated and non-regulated industries. A company in a listed industry must keep cost records for those products in Form CRA-1 if its overall turnover from all products and services in the preceding financial year was ₹35 crore or more. Companies classified as micro or small enterprises are excluded (proviso to rule 3). From 1 April 2025 a small enterprise may have turnover of up to ₹100 crore, with investment in plant and machinery of up to ₹25 crore. A company above the ₹35 crore line may therefore still fall outside the rules, and its classification should be checked each year.

How. Under rule 5, records are kept on a regular basis and must allow per-unit cost to be calculated. They must also follow generally accepted cost accounting principles and the Cost Accounting Standards issued by the Institute of Cost Accountants of India.

Cost audit. Where rule 4 applies, the cost records are audited. Its thresholds are higher than those for records. Regulated sectors need overall turnover of ₹50 crore or more, with ₹25 crore or more from the products covered; for non-regulated sectors the figures are ₹100 crore and ₹35 crore. Rule 4(3) exempts companies whose export revenue in foreign exchange exceeds 75% of total revenue, as well as companies operating from a special economic zone. Captive power generation is also exempt. The 2025 amendment to the rules changed the forms and left these thresholds as they were.

Who audits. Section 148(3) requires the cost auditor to be a Cost Accountant in practice. The board makes the appointment on the audit committee's recommendation, and shareholders ratify the remuneration. A company's statutory auditor cannot be its cost auditor, and the cost audit is a separate engagement with its own report.

The forms. In outline, the company informs MCA of the cost auditor's appointment in Form CRA-2. This is due within 30 days of the board meeting or 180 days from the start of the financial year, whichever is earlier. The cost auditor gives the report in Form CRA-3 to the board within 180 days from the end of the year, and the company files it with MCA in Form CRA-4 within 30 days of receipt. The Companies (Cost Records and Audit) Amendment Rules 2025 (G.S.R. 361(E), 30 May 2025, effective 14 July 2025) revised the content of CRA-2 and CRA-4. The time limits did not change.

Where section 148 does not apply, its discipline is still good practice: records kept by product and reconciled with the books, with a written basis for every rate.

8. Where cost sheets usually fail

• A labour rate set years ago and never reloaded for wage settlements or the Labour Codes.
• Overheads spread on actual output, so prices rise in slow months and fall in busy ones.
• Scrap credited at input price, or not credited at all.
• Rejection costed at zero because "it is only two per cent".
• Blocked or reversed GST ignored, which makes material look cheaper than it is.
• Tooling charged in the month of purchase, when it should be spread over the parts it produces.
• Job work charges left out of the sheet because they arrive on a separate bill.
• No reconciliation with the books, so the drift in the sheet goes unnoticed.

What this means for a manufacturer

• Build machine-hour rates by cell, and review them every year or when a machine is added.
• Fix normal capacity in writing for each cell, with CAS-2 as the guide, and report under-absorbed overhead as a separate line each month.
• Reload the labour rate for the Labour Codes, wage settlements and actual effective hours.
• Cost material at gross weight, less realisable scrap, grossed up for normal rejection. Report abnormal rejection separately.
• Keep price, usage and rate variances visible, since they show purchase, production and sales where action is needed.
• Reconcile the cost sheet with the profit and loss account every month, using the families of items above.
• Check each year whether your products and turnover in the preceding year bring the company under the cost records or cost audit rules.

This article is general information on the law and practice as at 1 October 2026 and is not advice on any particular case. Thresholds and forms under the cost records rules change; check the current MCA text before acting.