Question

Accounting question:

Please explain briefly:

1.Explain in detail why it is important to distinguish product cost from period cost and the impact an error will have on the income statement and balance sheet if manufacturing overhead is incorrectly labeled as a period cost.  

2. Explain the difference in cost breakdown between a traditional format income statement and a contribution format income statement? What benefit do you see in using one over the other? Which format is required by GAAP?

3.What are the difference between traditional income statement and contribution income statement?

4.compare direct cost and indirect cost

5.what is the significanse of balance sheet?

Answer 1

(1): It is important to distinguish product cost from period cost mainly because of two reasons. Firstly the distinction is important as it will enable the proper measurement of net income during a period of time. Secondly the distinction is important as it will enable the reporting of proper cost of inventory on the balance sheet of a company.

It should be noted that product costs holds on to the units of products manufactured (or purchased). If a unit of good is unsold then it will be reported as inventory (as a current asset in balance sheet). Product costs are reported as ‘cost of goods sold’ on the income statement. On the other period costs do not hold on to the units of products manufactured (or purchased). This is not included in the cost of inventory.

When manufacturing overhead is incorrectly labelled as a period cost then in the income statement the cost of goods sold will be higher (as manufacturing overheads will not be present). This will increase the gross margin by the amount of the manufacturing overhead. In the balance sheet the amount of closing inventory will be overstated. It should be noted that closing stock = opening stock+purchases – cost of goods sold. Due to incorrect labelling of manufacturing overhead as a period cost the cost of goods sold will be understated and hence the closing stock of inventory will be overstated in the balance sheet.