Question

How do you distinguish between product and period costs?

Please describe the three major components of product costs: direct materials, direct labor, and manufacturing overhead.

Answer 1

Product costs are those costs that are required to be incurred to manufacture a product and can be directly assigned to the product. For example, cost of materials required to manufacture a product, cost of labor required to manufacture a product, and the other manufacturing costs that are required to be incurred to carry on the manufacturing process smoothly. Whereas period costs are costs that are not related to manufacturing a product but are incurred for the purpose of administration of the whole company and to advertise and sell the product. For example, salaries to office employees, supplies consumed in the office, selling expenses and advertising expenses.

The major components of product costs can be described as follows:

Direct materials cost: These are costs incurred to purchase the raw materials that are required to manufacture a product. For example, the cost incurred to purchase cloth to manufacture shirts is a direct materials cost because cloth is the raw material required to manufacture a shirt. Similarly, the cost incurred to purchase thread to stich the shirts is also a direct materials cost.

Direct labor cost: These are the salaries and wages paid to workers who are directly involved in the manufacturing process. For example, the wages paid to the workers who cut the cloth in suitable pieces to manufacture a shirt and the wages paid to the workers who stich the pieces of cloth into a shirt are direct labor costs.

Manufacturing overhead: These are costs other than the direct materials cost and direct labor costs required to be incurred to manufacture a product. These are indirect costs that is these costs cannot be directly associated to a unit of product manufactured by are essential manufacturing costs without which the manufacturing process cannot be carried out. Examples of manufacturing overhead are factory rent, salary paid to factory supervisor, supplies and utilities consumed in the factory, costs incurred to maintain the equipment used in the manufacturing, etc.