What are Product Costs or Manufacturing Costs?

Product or manufacturing costs are all costs related to the production of goods. This might include material costs, wages, equipment and facilities, and commissions. Product costs are broken down further into:

• Direct materials
• Direct Labor
• Manufacturing Overhead

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What is a Direct Cost?

A direct costs are costs that can be directly linked or traced to the production of a particular item. Direct costs that can be linked to the production of a particular product can relate to the purchase of materials, commissions, fuel and other items needed for the production.

What is an Indirect Cost?

Indirect costs are expenses that are not easily attributable to the production of a good or service. These are generally costs incurred in the process of delivering the good or value proposition, but are not directly related to production. This might include employee salaries, storage, marketing, etc. 

What are Direct Materials?

Direct materials are the raw materials that are integrated into the product. 

What is Direct Labor?

Direct labor is the human hours of physical or mental labor required to produce a product. 

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What is Manufacturing Overhead?

Manufacturing overhead consists of:

• Indirect material costs - The cost of materials necessary to manufacture a product that are not easily traced to the product or not worth tracing to the product.
• Indirect labor costs - The cost of workers who are involved in the production process but whose time cannot easily be traced to the product. (Many supervisors in production process.)
• Other manufacturing Costs - These are all other costs for items associated with the factory, including equipment maintenance, insurance, utilities, quality control testing, and depreciation.

What are Period Costs or Non-Manufacturing Costs?

Period costs are those not related to the production of the product. Non-manufacturing costs are generally broken down into selling costs and general and administrative costs.

What are Selling Costs?

Selling costs are all of the costs associated with marketing, sale, and delivery of the product. These might include advertising, sales commissions, salaries for marketing and advertising personnel, office space for marketing and advertising personnel, finished goods storage costs, and seller's shipping costs.

General and Administrative Costs

Administrative costs are the costs of facilities, support personnel, and activities that are not directly related to production of the product. Often, these are administrative or professional service providers to the business, such as accounting, human resources, legal, executive, and information technology. The cost of facilities might include cost or depreciation expense associated with equipment or buildings. 

Product and Period Costs in Financial Statements

Manufacturing and non-manufacturing costs appear in separate locations in the financial statements. 

Manufacturing costs are recorded as an asset on the balance sheet in the form of inventory. When the goods are sold, these costs are recorded on the income statement as an expense. 

All manufacturing costs (direct materials, direct labor, and manufacturing overhead) are attached to inventory as an asset on the balance sheet until the goods are sold, at which point the costs are transferred to cost of goods sold on the income statement as an expense. 

Inventory Valuation Measurement

Given that many materials go into the production of goods and services, it is important that strict measures are put in place to monitor different materials as they are purchased at varying different amounts. For a company that uses direct costs, standard inventory valuation measurement must be used to avoid miscalculation of items which will affect the direct costs of production.