Classification of cost is very important for the management to identify the cost with respect to product, accounting period, in relation with different manufacturing departments. Relevant and accurate information of cost is quite a handful for the management to make the cost plans properly.
Manufacturing cost is the name of aggregate resources of direct material, direct labor and FOH, including the Work in Process inventory which is allocated to make the product. Manufacturing cost is also referred to as production cost. Manufacturing cost discusses the cost incurred on each unit produced. Through this estimation the management is able to value the units produced in a year, cost of goods sold and inventory which is then reported in the income statement and balance sheet of the company, respectively. Manufacturing costs include all cost from acquisition of material to conversion of finished goods. Like packing material, fuel expenses, lubricants used, depreciation on factory equipments, wages, repair and maintenance, etc. It is the sole responsibility of the management to monitor all activities related with manufacturing cost and examine the variances on each step. Any component of manufacturing cost like increases in wages, fluctuation in raw material prices may create a hurdle for the management to boost up the production units (Tatum, 2009). If the management is not keeping a watchful eye on manufacturing cost then it offsets the demands of higher production. It is the sole responsibility of the management to utilize every available resource in a fruitful manner. Like minimize the wastages and use every idle resource in producing more finished goods in a shorter span of time.
Product Cost vs. Period Cost
Product costs are those costs which are identifiable with the product either directly or indirectly. Product cost mainly consists of direct materials, direct labor, and factory overhead. These costs provide no substantial benefit until the product is sold. Moreover, if the product is sold it is recorded as Cost of Goods Sold in the books of accounts and then Cost of goods sold is matched against the revenue (matching principle). In short, product costs are those costs which are treated as inventory ready to be sold. They are treated as assets until the products are sold (Garrison, 2004).
All those cost which are not associated with the product cost are treated as a period cost. Period cost is treated as expenses and are directly reported to income statement in the period when they are incurred. Period cost are not debated over purchase or cost of goods manufactured. Period cost include all selling expense, general and administration expenses, interest expenses and income tax expenses (Garrison, 2004). In short, Period costs are reported on the income statement separated from the cost of goods sold section. The period cost is deducted from gross profit. Period cost is not essentially the part of the manufacturing process so therefore period cost is not treated as a cost of inventory (Meigs, 1999).
Another confusing factor between these two costs is deprecation. If the raw material is stored in warehouse then the depreciation on warehouse is considered as product cost because it is a part of manufacturing overhead while the manufacturing process is completed the finished goods are stored in warehouse and it is available for sale then the deprecation on warehouse is considered as period cost (Meigs, 1999). Another important thing to be taken into consideration is that both product and period cost have made significant impact on cash. The reporting of both the costs also makes an impression on the net income, cash flow and income taxes.
Garrison, Ray H, Eric Noreen, Peter C. Brewer (2004). Managerial Accounting.
Meigs, Robert F., Mary A.Meigs, Mark Bettner, Ray Whittington. Accounting: The basis for Business Decisions.10. McGraw Hill
Tatum, Malcolm (2009). What is Manufacturing Cost? Retrieved May 13, 2009, from Wisegeek Web site: