The materials, labor, and overhead costs incurred to produce a product are called period costs
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June 9, 2022 Hiring the right accountant When I meet a business owner operating at a successful $10 million in revenue, they often mention, “My CPA”… I immediately know that CEO/Entrepreneur is referring to their Tax CPA. That is because one thing that all Entrepreneurs
have in common is that they must file a tax return. So, from Read More » September 24, 2021 See also:Quick Ratio AnalysisPrice to Book Value AnalysisPrice Earnings Growth Ratio
AnalysisTime Interest Earned Ratio Analysis Use of Financial Ratios Financial Ratios are used to measure financial performance against standards. Analysts compare financial ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). The most useful comparison when Read More » June 8, 2021 The Difference in CPAs Looking back at my career I don’t know how many times I have introduced myself to someone and they ask, “Are you a CPA?” and I say yes. Then they tell me “you must be very busy with tax season” and I look at them with a bit of awe and Read More »
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Question: Much of what we discuss in this book relates to companies that manufacture products, such as Nike and Apple, and terminology is a key component of accounting for manufacturing companies. The challenge is in classifying costs correctly for items such as production materials, production labor, marketing department labor, rent for production facilities, and rent for the administrative services facilities. These costs must be classified accurately so that they appear correctly in company financial reports. The starting point for learning how to classify costs correctly is in understanding two broad categories of costs. What are the two broad terms used to categorize cost information in a manufacturing setting? Answer: The two broad categories of costs are manufacturing costs and nonmanufacturing costs. Each category is described in detail as follows. Manufacturing CostsAll costs related to the production of goods are called manufacturing costsAll costs related to the production of goods; also called product costs.; they are also referred to as product costsAll costs related to the production of goods; also called manufacturing costs.. A manufacturer purchases materials, employs workers who use the materials to assemble the goods, provides a building where the materials are stored and goods are assembled, and sells the goods. We classify the costs associated with these activities into three categories: direct materials, direct labor, and manufacturing overhead. To help clarify which costs are included in these three categories, let’s look at a furniture company that specializes in building custom wood tables called Custom Furniture Company. Each table is unique and built to customer specifications for use in homes (coffee tables and dining room tables) and offices (boardroom and meeting room tables). The sales price of each table varies significantly, from $1,000 to more than $30,000. Figure 1.4 "Direct Materials, Direct Labor, and Manufacturing Overhead at Custom Furniture Company" shows examples of production activities at Custom Furniture Company for each of the three categories (we continue using this company as an example in Chapter 2 "How Is Job Costing Used to Track Production Costs?"). Direct MaterialsQuestion: Raw materials used in the production process that are easily traced to the product are called direct materialsRaw materials used in the production process that are easily traced to the product.. What materials used in the production process at Custom Furniture would be classified as direct materials? Answer: The wood used to build tables and the hardware used to attach table legs would be considered direct materials. Small, inexpensive items like glue, nails, and masking tape are typically not included in direct materials because the cost of tracing these items to the product outweighs the benefit of having accurate cost data. These minor types of materials, often called supplies or indirect materials, are included in manufacturing overhead, which we define later. Direct LaborQuestion: Workers who convert materials into a finished product and whose time is easily traced to the product are called direct laborLabor performed by workers who convert materials into a finished product and whose time is easily traced to the product.. Who represents direct labor at Custom Furniture? Answer: Direct labor would include the workers who use the wood, hardware, glue, lacquer, and other materials to build tables. Manufacturing OverheadQuestion: All costs associated with the production process other than direct material costs and direct labor costs are called manufacturing overheadAll costs associated with the production process other than direct material costs and direct labor costs.. Terms synonymous with manufacturing overhead include factory overhead, factory burden, and overhead. What items are included in manufacturing overhead? Answer: Manufacturing overhead consists of the following:
Table 1.2 "Manufacturing Costs at Custom Furniture Company" provides several examples of manufacturing costs at Custom Furniture Company by category. Table 1.2 Manufacturing Costs at Custom Furniture Company
Note 1.43 "Business in Action 1.5" details the materials, labor, and manufacturing overhead at a company that has been producing boats since 1968. Business in Action 1.5Manufacturing Costs at MasterCraft MasterCraft produces boats for water skiers and wake boarders. Each boat produced incurs significant manufacturing costs. MasterCraft records these manufacturing costs as inventory on the balance sheet until the boats are sold, at which time the costs are transferred to cost of goods sold on the income statement. Examples of direct materials for each boat include the hull, engine, transmission, carpet, gauges, seats, windshield, and swim platform. Examples of indirect materials (part of manufacturing overhead) include glue, paint, and screws. Direct labor includes the production workers who assemble the boats and test them before they are shipped out. Indirect labor (part of manufacturing overhead) includes the production supervisors who oversee production for several different boats and product lines. Manufacturing overhead includes the indirect materials and indirect labor mentioned previously. Other manufacturing overhead items are factory building rent, maintenance and depreciation for production equipment, factory utilities, and quality control testing. Nonmanufacturing CostsCosts that are not related to the production of goods are called nonmanufacturing costsCosts that are not related to the production of goods; also called period costs.; they are also referred to as period costsCosts that are not related to the production of goods; also called nonmanufacturing costs.. These costs have two components—selling costs and general and administrative costs—which are described next. Examples of nonmanufacturing costs appear in Figure 1.5 "Examples of Nonmanufacturing Costs at Custom Furniture Company". Selling CostsQuestion: Costs incurred to obtain customer orders and provide customers with a finished product are called selling costsCosts incurred to obtain customer orders and provide customers with a finished product.. (They are also often called marketing costs or selling and advertising costs.) What activities would be classified as selling costs at Custom Furniture? Answer: Examples of selling costs include advertising, sales commissions, salaries for marketing and advertising personnel, office space for marketing and advertising personnel, finished goods storage costs, and shipping costs paid by the seller for products shipped to customers. General and Administrative CostsQuestion: Costs related to the overall management of an organization are called general and administrative costsCosts related to the overall management of an organization.. What activities would be classified as general and administrative costs at Custom Furniture? Answer: Examples include personnel and support staff in the following areas: accounting, human resources, legal, executive, and information technology. Depreciation of office equipment and buildings associated with these areas would also be included as general and administrative costs. General and administrative costs are often simply called administrative costs. Figure 1.5 Examples of Nonmanufacturing Costs at Custom Furniture Company Although selling costs and general and administrative costs are considered nonmanufacturing costs, managers often want to assign some of these costs to products for decision-making purposes. For example, sales commissions and shipping costs for a specific product could be assigned to the product. This does not comply with U.S. GAAP because, under U.S. GAAP, only product costs can be assigned to products. However, as we noted earlier, managerial accounting information is tailored to meet the needs of the users and need not follow U.S. GAAP. Distinguishing between manufacturing and nonmanufacturing costs is not always simple. For example, if legal staff works on an issue associated with production personnel and if human resources staff hires assembly line workers, are the costs involved manufacturing or nonmanufacturing costs? It is up to each organization to determine how to handle such costs for product costing purposes. The advantage of managerial accounting over financial accounting is that costs can be organized in any manner that helps managers make decisions. However, in this chapter, to avoid ambiguity, we follow the definitions provided by U.S. GAAP. Presentation of Manufacturing and Nonmanufacturing Costs in Financial StatementsQuestion: At this point, you should be able to distinguish between manufacturing costs and nonmanufacturing costs. Why is it important to make this distinction? Answer: Distinguishing between the two categories is critical because the category determines where a cost will appear in the financial statements. All manufacturing costs (direct materials, direct labor, and manufacturing overhead) are attached to inventory as an asset on the balance sheet until the goods are sold, at which point the costs are transferred to cost of goods sold on the income statement as an expense. As we indicated earlier, nonmanufacturing costs are also called period costs; that is because they are expensed on the income statement in the time period in which they are incurred. Table 1.3 "Manufacturing Versus Nonmanufacturing Costs" clarifies the relationship between manufacturing and nonmanufacturing costs. It also describes the point at which these costs are recorded as expenses on the income statement. (Remember that the terms manufacturing cost and product cost are interchangeable, as are the terms nonmanufacturing cost and period cost.) Table 1.3 Manufacturing Versus Nonmanufacturing Costs
Note 1.48 "Business in Action 1.6" provides examples of nonmanufacturing costs at PepsiCo, Inc. Business in Action 1.6Nonmanufacturing Costs at PepsiCo PepsiCo, Inc., produces more than 500 products under several different brand names, including Frito-Lay, Pepsi-Cola, Gatorade, Tropicana, and Quaker. Net sales for 2010 totaled $57,800,000,000, resulting in operating profits of $6,300,000,000. Cost of sales represented the highest cost on the income statement at $26,600,000,000. The second highest cost on the income statement—selling and general and administrative expenses—totaled $22,800,000,000. These expenses are period costs, meaning they must be expensed in the period in which they are incurred. Examples of selling costs for PepsiCo include television advertising (probably the biggest piece of the $22,800,000,000), promotional coupons, costs of shipping products to customers, and salaries of marketing and advertising personnel. Examples of general and administrative costs include salaries and bonuses of top executives and the costs of administrative departments, including personnel, accounting, legal, and information technology. Key Takeaway
Review Problem 1.6
Solution to Review Problem 1.6
What is period cost and product cost?Product costs are those directly related to the production of a product or service intended for sale. Period costs are all other indirect costs that are incurred in production. Overhead and sales and marketing expenses are common examples of period costs.
What is the period cost?Period costs are costs that cannot be capitalized on a company's balance sheet. In other words, they are expensed in the period incurred and appear on the income statement. Period costs are also called period expenses.
Are materials a period cost?Items That are Not Period Costs
Also, costs included in inventory, such as direct labor, direct materials, and manufacturing overhead, are not classified as period costs.
What is material cost & overhead cost?Manufacturing overhead (MOH) cost is the sum of all the indirect costs which are incurred while manufacturing a product. It is added to the cost of the final product along with the direct material and direct labor costs.
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