Product vs Period Costs

Things You Must Know

Medium to Hard Practice Test

Product Costs: Include all costs that are required to make a product

Are included as part of inventory and shown on the balance sheet until the product is sold. Product costs are often called “inventoriable costs” or “manufacturing costs”.

When the product is sold, the costs are “matched” to the sales revenue and reported on the income statement as cost of goods sold

Period Costs are selling, administrative, and warehouse costs:

Examples include costs related to:
• Selling and shipping the product, sales commissions, marketing, customer support
• Administrative salaries and facilities (corporate office) to run the company
• Warehouse costs and the people who move inventory (inventory control)

These costs are reported on the income statement as they are incurred.
Period costs are not part of manufacturing overhead and do not directly relate to making the product.

Period costs are reported on the income statement in the period they are incurred (service received or asset is used)

Other Terms That Are Used:

Prime Costs – direct materials plus direct labor

Conversion Costs – direct labor plus manufacturing overhead. What it costs to take the materials and convert them to a finished product

Direct Cost – a cost that can be easily and conveniently traced to one product. Direct costs are direct materials and direct labor

Indirect Cost – a cost that cannot be easily and conveniently traced to one product. Manufacturing overhead and period costs are indirect costs.

PRODUCT COSTS –

Product costs are costs that are incurred to manufacture products. They include anything that becomes part of the product, anyone who touches the product to make it, and all the costs of the facilities and management incurred to make the product. The three major categories of product costs are:

Direct Materials

– raw materials that become a part of the finished product

The cost is high enough that you want to keep track of what is used in each product. It is easy to track how much material is required for one product to be made. If the cost of a particular material can not be easily traced to one product, it is an indirect material and is part of manufacturing overhead. Examples of indirect materials are cheap screws, tape, glue.

Direct Labor

– workers that touch the product to make the product – also includes workers who operate the machine if the product is made by machine

Manufacturing Overhead

– all costs of manufacturing the product except direct materials and direct labor

Costs associated with operating the factory that makes the product. If the cost has the word “factory”, “plant”, “manufacturing”, as a descriptive word, the cost will be part of manufacturing overhead.

Manufacturing overhead includes things at the manufacturing plant that have to be incurred in order to get the product made, but is not part of the actual product or touches to make the product. It is indirect. You can not easily determine how much of these costs it takes to make one product. The total dollars spent support the manufacturing of many products.

Examples of manufacturing overhead costs are: – utilities at the plant such as electricity, water, phone. Support personnel at the plant such as an accountant, human resources or computer support. Training, maintenance and repairs, rent, insurance, taxes, etc. KEY – it has to happen at the manufacturing facility. Indirect labor and indirect material are part of manufacturing overhea

Indirect labor

– Involved in making the product at the plant but do not touch the product to make it. example: salaries of the plant managers, supervisors, and quality inspectors

Indirect Material

– low cost materials that end up in the product or are used to make the product. Examples are glue, tape, screw, marking pens, etc. It is not easy to track exactly how much is used to make one product.