Product Costs
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.
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Period Costs
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.
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Absorption Costing/
Full Costing Method
Absorption Costing Treats all manufacturing
costs as Product costs, regardless of whether
they are variable or fixed.
The cost of a unit of product under the
absorption costing method consists of direct
materials, direct labor and both variable and
fixed manufacturing overhead.
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Variable Costing/Direct
Costing/Marginal Costing
Under variable costing, only those
manufacturing costs that may vary with output
are treated as product costs.
This would usually include direct materials,
direct labor and the variable portion of
manufacturing overhead. Fixed manufacturing
overhead is not treated as Product cost here,
rather it is treated as Period Cost.
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Absorption Costing
Product
Costs
Period
Costs
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• Direct Materials
• Direct Labor
• Variable & Fixed
Manufacturing Overhead
• Variable & Fixed Selling
and Administrative
Expense
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Variable/Direct Costing
Product
Costs
Period
Costs
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• Direct Materials
• Direct Labor
• Variable Manufacturing
Overhead
• Fixed Manufacturing
Overhead
• Variable & Fixed Selling and
Administrative Expense
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Work Out Example - 01
Number of Units produced each year
6000
Variable Costs per unit:
Direct materials
2
Direct Labor
4
Variable manufacturing overhead
1
Variable selling & Administrative expense
3
Fixed Costs per year:
Fixed Manufacturing overhead
30,000
Fixed Selling & Administrative expense
10,000
Requirements:
1. Compute the unit product cost under Absorption Costing.
2. Compute the unit product cost under Variable Costing.
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Solution - 01
Particulars
Absorption Costing
Variable Costing
Direct materials
2
2
Direct Labor
4
4
Variable manufacturing overhead
1
1
Fixed Manufacturing overhead (30,000/6000Unit)
5
-
Unit Product Cost
12
7
Under Variable Costing, 30,000 Taka Fixed Manufacturing Overhead is a period cost.
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Work Out Example - 02
Using the cost information used in Work out example – 01, Complete the followings:
Particulars
Units in the beginning inventory
Unit/Taka
0
Units produced
6000
Units Sold
5000
Units in Ending Inventory
1000
Selling price per unit
BDT 20
Selling & Variable Expenses:
Variable per unit
Fixed per Year
BDT 3
BDT 10,000
Requirements:
1. Prepare the income Statement under Absorption Costing Method.
2. Prepare the income Statement under Variable Costing Method.
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Solution - 02
Calculation of Unit Product Costs
Particulars
Absorption Costing
Variable Costing
Direct materials
2
2
Direct Labor
4
4
Variable manufacturing overhead
1
1
Fixed Manufacturing overhead (30,000/6000Unit)
5
-
Unit Product Cost
12
7
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Income Statement – Absorption Costing
Particulars
Taka
Sales (5000 Units * 20 BDT)
1,00,000
Less: Cost of Goods Sold (5000 Units * 12)
(60,000)
Gross Profit
Less: Selling & Administrative Expenses (5000 Units * 3 BDT + 10,000 BDT Fixed)
Net Operating Income
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40,000
(25,000)
15,000
11
Income Statement – Variable Costing
Particulars
Taka
Sales (5000 Units * 20 BDT)
1,00,000
Less: Variable Expenses:
Product Cost (5000 Units * 7 BDT)
(35,000)
Variable Selling & Admin Expense (5000 Units * 3)
(15,000)
Contribution Margin
50000
Less: Fixed Expenses:
Fixed Manufacturing Overhead
(30,000)
Fixed Selling & Administrative Expenses
(10,000)
Net Operating Income
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10,000
12
Read It at Home
Advantages
of
Variable Costing
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Review Problem
Selling Price Per unit
Manufacturing Costs:
Variable per unit produced:
Direct Materials
Direct Labor
Variable Overhead
Fixed Per year
Selling & Administrative Costs:
Variable per unit sold
Fixed Per Year
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50
11
6
3
1,20,000
4
70,000
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Year 1
Year 2
0
2,000
Units Produced During the Year
10,000
6,000
Units sold during the Year
8,000
8,000
Units in Ending Inventory
2,000
0
Units in Beginning Inventory
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Requirements
1. Assume the company uses absorption costing.
a) Compute the unit product cost in each year.
b) Prepare an income statement for each year.
2. Assume the company uses Variable costing.
a) Compute the unit product cost in each year.
b) Prepare an income statement for each year.
3. Reconcile the variable costing and absorption
costing net operating income.
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