Income Statement
Costs can also be classified as product or period costs.
Product costs include all the costs that are involved in acquiring or making a product. More specifically, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. The discussion in the chapter follows the usual interpretation of GAAP in which all manufacturing costs are treated as product costs.
Period costs include all selling costs and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are “incurred” when they are earned by the employees and not necessarily when they are paid to employees.
Classifications of Costs
Manufacturing costs are often classified as follows:
Direct Material
Direct Labor
Manufacturing Overhead
Prime Cost
Conversion Cost
Two more cost categories are often used in discussions of manufacturing costs—prime cost and conversion cost. Prime cost is the sum of direct materials cost and direct labor cost. Conversion cost is the sum of direct labor cost and manufacturing overhead cost. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.
Review Questions T/F
11. Although depreciation is always a period cost in a merchandising firm, it can be a product cost in a manufacturing firm.
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True
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12. In a manufacturing firm, all costs are product costs.
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False
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13. The cost of shipping parts from a supplier is considered a product cost.
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True
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14.The costs of acquiring inventory are reported on the balance sheet as an asset labeled “inventory” and are expensed only when products are sold.
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True
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15.The cost of selling goods and administrative costs are reported on the income statement as expenses when inventory is sold.
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False – The cost of selling goods and administrative costs are reported on the income statement as expenses when they are incurred.
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16.Product costs are the costs related to inventory and period costs are the costs related to the selling and administrative functions.
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True
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17. Product costs are any costs that a company incurs to acquire raw materials and convert them to finished goods ready for sale.
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True
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18. The advertising costs that Pepsi incurred to air its commercials during the Super Bowl can best be described as a: A. variable cost. B. fixed cost. C. product cost. D. prime cost.
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B. fixed cost.
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19. Each of the following would be a period cost except: A. the salary of the company president’s secretary. B. the cost of a general accounting office. C. depreciation of a machine used in manufacturing. D. sales commissions.
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C. depreciation of a machine used in manufacturing.
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20. Which of the following costs is an example of a period rather than a product cost? A. Depreciation on production equipment. B. Wages of salespersons. C. Wages of production machine operators. D. Insurance on production equipment.