A manufacturer's product costs are the direct materials, direct labor, and manufacturing overhead used in making its products. (Manufacturing overhead is also referred to as factory overhead, indirect manufacturing costs, and burden.) The product costs of direct materials, direct labor, and manufacturing overhead are also "inventoriable" costs, since these are the necessary costs of manufacturing the products.
Period costs are not a necessary part of the manufacturing process. As a result, period costs cannot be assigned to the products or to the cost of inventory. The period costs are usually associated with the selling function of the business or its general administration. The period costs are reported as expenses in the accounting period in which they 1) best match with revenues, 2) when they expire, or 3) in the current accounting period. In addition to the selling and general administrative expenses, most interest expense is a period expense.
What is a product cost?
Product cost meaning: In accounting, a retailer’s product cost is the cost paid to a supplier plus any other costs that are necessary to get the product in place and ready for sale. For example, if a retailer pays $40 to its supplier and then pays $10 to get it delivered to its warehouse, the retailer’s product cost is $50. (Other costs such as the selling, general, administrative and interest costs are not product costs. Instead these are period costs since they are expensed in the accounting period in which they occur.)
A manufacturer’s product cost includes the cost of each product’s raw materials plus the costs of converting those raw materials into the product. The manufacturer's product costs are often classified into three groups:
· Raw materials used in the product
· Direct labor used to make the product
· manufacturing overhead incurred to make the product
A manufacturer's selling, general, administrative and interest costs are not product costs and will be expensed in the accounting period in which they are incurred.
Both the product costs of a retailer and the product costs of a manufacturer are also referred to as inventoriable costs, since the product costs are used to value their goods in inventory. When the goods are sold, the product costs will be removed from inventory and will appear on the income statement as the cost of goods sold.
Examples of manufacturing overhead costs: The following are some examples of a manufacturer’s overhead costs, which are also referred to as indirect manufacturing costs:
· Gas and electricity used in the production facilities
· Repairs and maintenance of the production equipment and buildings
· Indirect factory workers' compensation
· Depreciation of the manufacturing equipment and buildings
· Manufacturing supplies, quality assurance, etc.
Since the manufacturing overhead costs are indirect costs, they need to be allocated to the products manufactured to comply with financial accounting standards and U.S. income tax regulations. The details for allocating or assigning the manufacturing costs to the products manufactured are contained in the college course known as cost accountingor managerial accounting.
What is the difference between prime costs and conversion costs?
The difference between prime costs and conversion costs involves the three cost categories associated with manufacturing a product:
· direct materials
· direct labor
· and manufacturing overhead (also known as factory overhead, production overhead, burden, indirect product costs, etc.)
Prime costs are the two direct product costs. (The indirect product cost manufacturing overhead is excluded.). Hence, the prime costs are:
· direct materials costs
· direct labor costs
· Conversion costs are the manufacturing costs needed to convert the direct materials into products. Hence, conversion costs exclude the cost of direct materials and consist of the following:
· direct labor costs
· manufacturing overhead costs
As you can see, the direct labor costs are both a prime cost and a conversion cost.
AccountingCoach PRO contains a cost and managerial exam with 520 questions and answers to assist you in a better understanding of manufacturing costs.
Relevant costs are those costs that will make a difference in a decision. Relevant costs are future costs that will differ among alternatives.
We can demonstrate relevant costs with the following situation. A company is deciding whether or not to eliminate a product line. The product line accounts for approximately 4% of the company's activities. If the product line is eliminated, the officers of the corporation will continue to receive the same salaries and the central office expenses will not change. The product line managers and other employees working directly on the product line will be terminated. Hence, their salaries will be eliminated.
The salaries of the product line managers and other employees whose salaries will be eliminated are relevant to the decision. If these salaries are $700,000 with the product line and $0 without the product line, the $700,000 of savings is relevant. Those cost savings and other possible cost savings will be considered along with the loss of sales revenues.
On the other hand, the officers' salaries are not relevant in the decision. In other words, it doesn't matter if the officers' salaries are $500,000 or $5,000,000. The officers' salaries will be the same with or without the product line. Similarly, the decision maker does not need to know the amount of its central office expenses, since they will be the same with or without the product line. Expenses from previous years are also irrelevant.
To recap, relevant costs are the future costs that will differ among alternatives. You might use the past costs to help you predict those future costs, but the past costs are otherwise irrelevant to the decision. Accountants refer to the past costs as sunk costs.