Product Costs in Accounting: Definition & Examples

Product Costs in Accounting: Definition & Examples
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  • 0:02 What Are Product Costs?
  • 1:05 Period Costs
  • 1:38 Product Costs Affect…
  • 3:45 Lesson Summary
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Lesson Transcript
Instructor: Christian George
This lesson provides the definition and example of what product costs are, how they differentiate from period costs, and how they are used on a cost of goods manufactured schedule in relation to financial statements.

What Are Product Costs?

XYZ, Inc. is a company that manufactures telephone wire for businesses that wire homes and other buildings for their telecommunications needs. They currently have a plant located in Nebraska that employs 100 people, which includes production, support staff, and management. The process of manufacturing telephone wire requires five different machines located on five different production lines.

Before beginning production, XYZ will need to determine what the product costs are. Product costs are all of the costs associated with the manufacturing of a product that is intended for sale to customers. For the purpose of company XYZ, the product costs are direct materials, direct labor, and manufacturing overhead.

Direct materials are the raw materials used to manufacture the telephone wire. Direct labor is all of the manufacturing labor required to complete the manufacturing process. Manufacturing overhead are the auxiliary costs to manufacture the telephone wire, such as electricity to run the machines.

Period Costs

It is important to note the difference between product costs and period costs. The selling and administrative costs associated with the sale of goods are recorded as an expense. This is called a period cost. This cost is differentiated from product costs because it is not directly related to the manufacturing of the product. This type of expense can occur at any time before, during, or after the manufacturing process but must be recorded in the time period in which it occurs. This type of expense is completely independent of product costs.

Product Costs Affect Financial Statements

The allocation of product costs affect the financial statements of XYZ in different ways. When cash, an asset on the balance sheet, is used to buy raw materials, the raw materials are an inventory asset on the balance sheet. After the manufacturing process, XYZ still has the telephone wire in its warehouse, so the telephone wire is an inventory asset on the balance sheet. When the telephone wire is sold to a customer, the costs moves from the balance sheet to the income statement under cost of goods sold (COGS). COGS is subtracted from the selling price of the telephone wire to compute the gross profit of the sale.

Example

Let's look at an example with XYZ, Inc. showing the manufacturing process and how the product costs are allocated to financial statements.

XYZ, Inc. began Quarter 1 of 2015 with $50,000 in cash. They buy raw materials for $2,000. This is all of the raw materials required to manufacture a batch of telephone wire. On the balance sheet, we add $2,000 to inventory and subtract $2,000 from cash for the purchase.

Balance Sheet, 2015 Quarter 1

Assets
Cash $48,000
Inventory $2,000

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