Question

1. What are the three basic manufacturing cost categories?

2. What are the main difference between product costs and period costs? Give examples of each.

3. What is the difference between a fixed cost and a variable cost? Give examples of each.

4. What are differential costs? Opportunity costs? Sunk costs? Be specific and give examples of each.

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Answer 1

• Three basic manufacturing cost categories are

1    Direct materials cost

2    Direct labor cost

3    Manufacturing overhead

• Difference between product costs and period costs are

A manufacturer's product costs are the direct materials, direct labor, and manufacturing overhead used in making its products. (Manufacturing overhead is also referred to as factory overhead, indirect manufacturing costs, and burden.) The product costs of direct materials, direct labor, and manufacturing overhead are also "inventoriable" costs, since these are the necessary costs of manufacturing the products.

Period costs are not a necessary part of the manufacturing process. As a result, period costs cannot be assigned to the products or to the cost of inventory. The period costs are usually associated with the selling function of the business or its general administration. The period costs are reported as expenses in the accounting period in which they 1) best match with revenues, 2) when they expire, or 3) in the current accounting period. In addition to the selling and general administrative expenses, most interest expense is a period expense.

• Difference Between Variable Cost and Fixed Cost

A variable cost is a company's cost that is associated with the amount of goods or services it produces. A company's variable cost increases and decreases with the production volume. For example, suppose company ABC produces ceramic mugs for a cost of $2 a mug. If the company produces 500 units, its variable cost will be $1,000. However, if the company does not produce any units, it will not have any variable cost for producing the mugs.

On the other hand, a fixed cost does not vary with the volume of production. A fixed cost does not change with the amount of goods or services a company produces. It remains the same even if no goods or services are produced. Using the same example above, suppose company ABC has a fixed cost of $10,000 per month for the machine it uses to produce mugs. If the company does not produce any mugs for the month, it would still have to pay $10,000 for the cost of renting the machine. On the other hand, if it produces 1 million mugs, its fixed cost remains the same. The variable costs change from zero to $2 million in this example.

• Differential costs

Differential cost is the difference between the cost of two alternative decisions, or of a change in output levels. The concept is used when there are multiple possible options to pursue, and a choice must be made to select one option and drop the others.

• Opportunity Cost

Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made. This cost is, therefore, most relevant for two mutually exclusive events. In investing, it is the difference in return between a chosen investment and one that is necessarily passed up.

• Sunk Cost

In economics and business decision-making, a sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs (also known as retrospective costs) are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken.