Costs incurred in manufacturing a product
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What are Product Costs?
Product costs are costs that are incurred to create a product that is intended for sale to customers. Product costs include direct material (DM), direct labor (DL), and manufacturing overhead (MOH).
Understanding the Costs in Product Costs
Product costs are the costs directly incurred from the manufacturing process. The three basic categories of product costs are detailed below:
1. Direct material
Direct material costs are the costs of raw materials or parts that go directly into producing products. For example, if Company A is a toy manufacturer, an example of a direct material cost would be the plastic used to make the toys.
2. Direct labor
Direct labor costs are the wages, benefits, and insurance that are paid to employees who are directly involved in manufacturing and producing the goods – for example, workers on the assembly line or those who use the machinery to make the products.
3. Manufacturing overhead
Manufacturing overhead costs include direct factory-related costs that are incurred when producing a product, such as the cost of machinery and the cost to operate the machinery. Manufacturing overhead costs also include some indirect costs, such as the following:
- Indirect materials: Indirect materials are materials that are used in the production process but that are not directly traceable to the product. For example, glue, oil, tape, cleaning supplies, etc. are classified as indirect materials.
- Indirect labor: Indirect labor is the labor of those who are not directly involved in the production of the products. An example would be security guards, supervisors, and quality assurance workers in the factory. Their wages and benefits would be classified as indirect labor costs.
Example of Product Costs
Company A is a manufacturer of tables. Its product costs may include:
- Direct material: The cost of wood used to create the tables.
- Direct labor: The cost of wages and benefits for the carpenters to create the tables.
- Manufacturing overhead (indirect material): The cost of nails used to hold the tables together.
- Manufacturing overhead (indirect labor): The cost of wages and benefits for the security guards to overlook the manufacturing facility
- Manufacturing overhead (other): The cost of factory utilities.
Company A produced 1,000 tables. To produce 1,000 tables, the company incurred costs of:
- $12,000 on wood
- $2,000 on wages for carpenters and $500 on wages for security guards to overlook the manufacturing facility
- $100 for a bag of nails to hold the tables together
- $500 for factory rent and utilities
Total product costs: $12,000 (direct material) + $2,000 (direct labor) + $100 (indirect material) + $500 (indirect labor) + $500 (other costs) = $15,100. As this is the cost to produce 1,000 tables, the company has a per unit cost of $15.10 ($15,100 / 1,000 = $15.10).
Period Costs
Product costs are costs necessary to manufacture a product, while period costs are non-manufacturing costs that are expensed within an accounting period.
| Product Costs | Period Costs |
|---|
| Definition | Costs incurred to manufacture a product | Costs that are not incurred to manufacture a product and, therefore, cannot be assigned to the product |
| Comprises of: | Manufacturing and production costs | Non-manufacturing costs |
| Examples | Raw material, wages on labor, production overheads, rent on the factory, etc. | Marketing costs, sales costs, audit fees, rent on the office building, etc. |
Consider the diagram below:
Costs on Financial Statements
Product costs are treated as inventory (an asset) on the balance sheet and do not appear on the income statement as costs of goods sold until the product is sold.
For example, a company manufactures 50 units of widgets at a unit product cost of $5. On the balance sheet, there would be a $5 x 50 = $250 increase in inventory. If the company sells 20 units of widgets, $5 x 20 = $100 in inventory would be transferred to the cost of goods sold on the income statement while the remaining $150 would remain in inventory on the balance sheet.
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FAQs
Product cost is an accounting term that refers to the total costs involved in making a product and getting it ready for sale. In manufacturing, product costs are expenditures that include the cost of raw materials, labor and manufacturing overhead.
What is a product cost quizlet? ›
Product costs include any materials that become part of the product, the cost of workers who touch the product to make it and all the costs of the facility and management required to make the product. The three major categories of product costs are: direct materials, direct labor and manufacturing overhead.
What is a good way to determine actual product costs? ›
Total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs. 1 Data like the cost of production per unit or the cost to produce one batch of product can help a business set an appropriate sales price for the finished item.
What is an example of production cost? ›
The equation looks like this:Cost per unit = (total fixed costs + total variable costs) / total units producedFor instance, suppose a company produced 200 units of an 80-pound bag of cat food in March 2022. In terms of rent, salaries and other overhead, its fixed cost of production each month is $6,000.
What is a cost short answer? ›
Cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost.
What are product costs also called? ›
Product costs are also known as inventoriable costs since they contribute to the creation of a company's inventory. These costs include various resources that contribute to inventory, such as labor, materials and other overhead expenses.
What is in total product cost? ›
These costs may be fixed (most overhead) or variable (raw materials and labor). The total product cost formula is Total Product Cost = Cost of Raw Materials + Cost of Direct Labor + Cost of Overhead. Another useful measure is the production cost per unit.
Which of the following is true of product costs? ›
The correct answer is c. They are first recorded in an inventory account. Product costs are costs to be recorded as part of inventory: Raw materials inventory if the materials were not yet used in the production.
What are the three product costs and define them? ›
The three elements of product costs are: Direct labor: The direct labor costs of manufacturing the product. Direct materials: The direct material costs used in manufacturing the product. Factory overhead: Indirect materials and indirect labor costs used in manufacturing the product.
Why is product cost important? ›
Product costing plays a pivotal role in the success and financial health of any business, regardless of its size or industry. It serves as a critical tool that enables companies to make informed and strategic decisions that can directly impact profitability and overall business performance.
Cost structure refers to the various types of expenses a business incurs and is typically composed of fixed and variable costs, or direct and indirect costs. Fixed costs are incurred regularly and are unlikely to fluctuate over time. Variable costs are expenses that vary with production output.
What is an example of actual costing? ›
For example, an auto repair shop may estimate that vehicle repairs will cost $1100, but the actual cost may actually be $1200. A customer might not be aware of the actual cost until the expenses are incurred during the repairs.
What increases cost of production? ›
The high costs of energy, materials and labour are increasing the cost of production and therefore raising the price of products.
What is cost of production simple? ›
Costs of production refer to all the expenses incurred in the process of creating and delivering a product or service. These expenses can include raw materials, labour, equipment, rent, and marketing costs. In simple terms, it is the sum of all expenses necessary to produce and sell a product or service.
What are major production costs? ›
Production cost factors typically include labor, raw materials, equipment, rent, and other supplies or overhead. Although production costs are generally associated with businesses like manufacturers with high inventory levels, they affect all types of businesses.
What is a cost quizlet? ›
Definition of cost. the monetary value of resources used or consumed in the production of a good/service.
What is cost of product in economics? ›
Costs of production - Key takeaways
The total cost is the aggregate cost incurred by a company of producing a given output level. We calculate it by adding the fixed costs and variable costs. We calculate the average cost, or unit cost, by dividing the firm's total cost of production by the quantity of output produced.
What is product price and product cost? ›
Cost is typically the expense incurred for making a product or service that is sold by a company. Price is the amount a customer is willing to pay for a product or service. The cost of producing a product has a direct impact on both the price of the product and the profit earned from its sale.
Which is not an example of a product cost quizlet? ›
Which is not an example of a product cost? Commissions paid on goods sold last month.
