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Elements of Product Cost and Manufacturing Business

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Jed Castaneda

on 15 June 2014

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Transcript of Elements of Product Cost and Manufacturing Business

Castaneda, Lexus Jed
Peralta, Froilan
- the cost incurred when an asset is used up or sold for the purpose of generating revenue.
Product Cost
cost assigned to goods that were either purchased or manufactured for resale. The product cost is used to value the inventory of manufactured goods or merchandise until the goods are sold. In the period of the sale, the product costs are recognized as an expense called
cost of goods sold.
The product cost of merchandise inventory acquired by a retailer or wholesaler for resale consists of the purchase cost of the inventory plus any shipping charges. The product cost of manufactured inventory includes all of the costs incurred in its manufacture. For example, the labor cost of a production employee at Texas Instruments is included as a product cost of the calculators manufactured.
Another term of product cost is
inventoriable cost
, since a product cost is stored at the cost of inventory until the goods are sold. In addition to retailers, wholesalers and manufacturers, the concept of product cost is relevant to other producers. Agriculture firms, lumber companies, and mining firms are examples of nonmanufacturers that produce inventoriable goods. Apple, timber, coal, and other goods are inventoried at their product cost until the time period during which they are sold.
Work Experience
"Elements of Product Cost and Manufacturing Business"
Cost Accounting:
Manufacturing Cost Flows
The End
Bacani, Rizzalyn
Period Costs
- all costs that are not product costs. These costs are identified with the period of time in which they are incurred rather than with units of purchased or produced goods. Period costs are recognized as expenses during the time in which they are incurred. All research and development, selling, and administrative costs are treated as period costs. This is true in manufacturing, retail, and service industry firms.
Product costs or Inventoriable costs
Direct Materials
Direct Labor
Manufacturing Overhead
Materials that can be physically and conveniently traced to a product
called as touch labor cost that can be physically and conveniently traced to a product
all costs of maturing a product other than direct materials and direct labor
Period Costs or Non-Manufacturing Costs
Marketing or selling costs
Administrative Costs
Direct Materials
Indirect Materials
--> the cost of the raw materials and components used to create a product. The materials must be easily identifiable with the resulting product (otherwise they are considered to be joint costs). The direct material cost is one of the few variable costs involved in the production process; as such, it is used in the derivation of throughput from production processes. Throughput is sales minus all totally variable expenses.
Direct Material Costs
Examples of direct materials are:

The timber used to construct a house
The steel included in an automobile
The circuit board included in a radio
The fabric used to assemble clothing
Prime Cost
--> is a way of measuring the total cost of the production inputs needed to create a given output. By analyzing its prime costs, a company can determine how much it must charge for its finished product in order to make a profit. By lowering its prime costs, a company can increase its profit margin and/or undercut its competitors' prices.
For example, the prime costs for creating a can of soda would include raw materials such as the aluminum needed for the cans, ink to customize the cans with the product's brand name and logo, soda ingredients (i.e. carbonated water, caramel coloring, caffeine, sugar or aspartame and preservatives), freight charges to transport the raw materials to the manufacturing plant and the wages, taxes and benefits paid to or on behalf of the employees involved in the soda manufacturing process.
---> materials used in the production process, but which cannot be linked to a specific product or job. Alternatively, they may be used in such insubstantial quantities on a per-product basis that it is not worthwhile to track them as direct materials (which involves including them in the bill of materials).
Indirect Material Cost
--> costs that are not directly accountable to a cost object (such as a particular project, facility, function or product). Indirect costs may be either fixed or variable. Indirect costs include administration, personnel and security costs. These are those costs which are not directly related to production. Some indirect costs may be overhead. But some overhead costs can be directly attributed to a project and are direct costs.
Thus, they are consumed as part of the production process, but are not integrated in substantial amounts into a product or job.

Examples of indirect materials are:

Cleaning supplies
Disposable safety equipment
Disposable tools
Fittings and fasteners
Accounting Methods
Indirect materials can be accounted for in one of two ways:

1) They are included in manufacturing overhead, and are allocated to the cost of goods sold and ending inventory at the end of each accounting period based on some reasonable method of allocation.

2) They are charged to expense as incurred.

Of the two accounting methods, inclusion in manufacturing overhead is considered more theoretically accurate, but if the amount of indirect materials is small, it is quite acceptable to instead charge them to expense as incurred.

Indirect materials are not usually tracked through a formal inventory record keeping system. Instead, an informal system is used to determine when to order additional indirect materials.
Direct Labor
Indirect Labor
Direct Labor Cost
--> wages that are incurred in order to produce specific goods or provide specific services to customers. The total amount of direct labor cost is much more than wages paid. It also includes the payroll taxes associated with those wages, plus the cost of company-paid medical insurance, life insurance, workers' compensation insurance, any company-matched pension contributions, and other company benefits.

Direct labor costs are most commonly associated with products in a job costing environment, where the production staff is expected to record the time they spend working on various jobs. This can be a substantial chore if employees work on a multitude of different products.
A strong case can be made in some production environments that direct labor does not really exist, and should be categorized as indirect labor, because production employees will not be sent home (and therefore not be paid) if one less unit of product is manufactured - instead, direct labor hours tend to be incurred at the same steady rate, irrespective of production volume levels, and so should be considered part of the general overhead costs associated with running a production operation.
In the direct labor cost we need to have the job time and wage we will pay it to the worker to calculate the direct labor cost as in this formulation:
Direct Labor Cost= job time x wage
--> describes wages paid to workers that perform tasks that do not directly contribute to the production of goods or performance of services, such as support workers who help enable others to produce goods.

For instance, a factory might employ janitors to keep facilities clean, foremen to oversee production workers and security guards to keep facilities safe. All of these workers are involved in indirect labor, because they do not actually produce any goods.

Examples of other workers engaged in indirect labor include managers, accountants and maintenance staff

Indirect Labor Cost
Overhead Costs
--> Those costs required to run a business, but which cannot be directly attributed to any specific business activity, product, or service. Thus, overhead costs do not directly lead to the generation of profits. Overhead is still necessary, since it provides critical support for the generation of profit-making activities. For example, a high-end clothier must pay a substantial amount for rent (a type of overhead) in order to be located in an adequate facility for the sale of clothes. The clothier must pay overhead to create the proper sale environment for its customers.
Examples of overhead are:
Accounting and legal expenses
Administrative salaries
In overhead, we can include indirect material cost, indirect labour cost and other following indirect expenses.

i) manufacturing overheads
ii) administrative overheads
iii) selling overheads
iv) research and development cost
Factory rent and rates, insurance of plants or telephone bill are the main examples of overheads.
Conversion cost
Conversion costs are those costs required to convert raw materials into finished goods that are ready for sale. The concept is used in cost accounting to derive the value of ending inventory, which is then reported in the financial statements. It can also be used to determine the incremental cost of creating a product, which could be useful for price setting purposes.

Since conversion activities involve labor and manufacturing overhead, the calculation of conversion costs is:

Conversion costs = Direct labor + Manufacturing overhead

Thus, conversion costs are all manufacturing costs except for the cost of raw materials.
Examples of costs that may be considered conversion costs are:
Direct labor and related benefits
Equipment depreciation
Equipment maintenance
Factory rent
Factory supplies
Factory insurance
Production utilities
Production supervision
Small tools charged to expense

As can be seen from the list, the bulk of all conversion costs are likely to be in the manufacturing overhead classification.
Direct material, direct labor, and manufacturing overhead are the three types of production costs incurred by manufacturers. These costs are product costs because they are stored in inventory until the time period when the manufacturer’s products are sold. Manufacturers have product-costing systems to keep track of the flow of these costs from the time production begins until finished products are sold. This flow of manufacturing costs is depicted in the Exhibit 2-6. As direct material is consumed in production, its cost is added to work-in-process inventory. Similarly, the costs of direct labor and manufacturing overhead are accumulated in work in process.
When products are finished, their costs are transferred from work-in-process inventory to finished-goods inventory. The total cost of direct material, direct labor, and manufacturing overhead transferred from work-in-process inventory to finished-goods inventory is called the cost of goods manufactured. The costs then are stored in finished goods until the time period when the products are sold. At that time, the product costs are transferred from finished goods to cost of goods sold, which is an expense of the period when the sale is made.  Exhibit 2-6 concentrates on the conceptual basis of a product-costing system
Manufacturers generally prepare a schedule of cost of goods manufactured and a schedule of cost of goods sold to summarize the flow of manufacturing costs during an accounting period. These schedules are intended for internal use by management and are generally not made available to the public. The Excel spreadsheets in Exhibit 2-7 show these two schedules along with an income statement for Comet Computer Corporation.7 Notice the extremely low inventories of raw material, finished goods, and work in process in these schedules. With annual sales of $700 million, Comet’s year-end inventory of raw material is only $5,020,000, which is less than 1 percent of sales. Work-in-process inventory ($100,000) and finished-goods inventory ($190,000) are even lower. These low inventories, relative to sales volume, are characteristic of mass customizers using the direct-sales approach.
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