Why Product Costing

For To
Financial Determine
Statement Sales
Purposes Price

Product Costing

To
For Tax
Project
Purpose
Profits
 Types of Companies

Manufacturing: Take raw materials and

produce new products from them.
Merchandising: Retail and wholesale
merchandising companies sell products
that someone else has manufactured.
Service: Provide a service such as
airlines, hospitals, repair shops, software,
Banks etc.
 Inventories in a Traditional
Environment
• Inventories serve as buffers in case of
unexpected demand for products or
unexpected problems in production.

Three different inventories exist in a traditional

environment:
 Manufacturing in a Traditional
Environment
Raw Finished
Materials PUSH Goods
Inventory
PUSH
Additional
Process 1 Processes

Similar Machines Grouped Together

Fill Customer
Orders
 Lean Production and
a JIT Environment

Customer Contact
Suppliers
Orders

PULL
PULL

MANUFACTURING CELLS
All Machines in One Area Grouped
Together
 Manufacturing Versus Non-
manufacturing Costs
Manufacturing Costs
Costs incurred in the factory
or plant
Nonmanufacturing Costs
Costs that are incurred outside the
plant or factory and typically
categorized as selling and
administrative costs.
 Manufacturing Costs
Direct Direct Manufacturing
Materials Labor Overhead
• Various •Labor costs •Indirect materials
materials that of assembly- such as welding
can be directly line workers. material, glue,
and screws, etc.
conveniently •Indirect labor such
traced to a as factory
product. maintenance
workers and
factory janitors
•Other factory costs
Direct Versus Indirect Costs
Nonmanufacturing Costs
Also called Period
Costs.

Nonmanufacturing Costs
are not directly incurred
in the production of
products. They are
typically selling and
administrative costs.
Expensed on
the income
statement.
 Nonmanufacturing Costs

ns e Taxe
pe nc
s
e
Ex ra
su
In

Examples of
Nonmanufacturing
Costs include:

ts s
Co
Rent

ing
tis
Expense

er
v
Ad
 Cost Flows in a
Traditional Manufacturing Environment

As Goods
Direct
Are Finished
Materials

Cost of
Work-in- Finished
Direct Labor Goods
Process Goods
Sold

Manufacturing
Overhead
As Goods
Are SOLD
 Merchandising Companies
“Schedule of Cost of Goods Sold”
A Merchandising Company
SCHEDULE OF COST OF GOODS SOLD
FOR THE YEAR ENDED March 31, XXXX
Beginning Merchandise Inventory Rs.xxx
Add: Purchases xxx,xxx
Goods Available for Sale Rs.xxx,xxx
Deduct: Ending Merchandise Inventory x,xxx
Cost of Goods Sold Rs.xxx,xxx
 Merchandising Companies:
Income Statement
A Merchandising Company
INCOME STATEMENT
FOR THE YEAR ENDED March 31, XXXX
Sales Rs.xxx,xxx
Cost of Goods Sold:
Beginning Merchandise Inventory Rs.xx,xxx
Add: Purchases xxx,xxx
Goods Available for Sale Rs.xxx,xxx
Deduct: Ending Merchandise Inventory x,xxx xxx,xxx
Gross Margin xxx,xxx
Less: Selling and Administrative Expense xxx,xxx
Net Operating Income Rs.xxx,xxx
 Service Companies and the Cost of
Services
• Many similarities exist between the costing of
products in a manufacturing company and the
costing of services.
• Income statements of service providers typically refer
to the “cost of services” as the “cost of revenue.”
• They typically have a small amount of material costs
and large amounts of labor and overhead.

15
 Product Costs and Period Costs

Direct
Materials
As
Products
Are SOLD
Direct Labor As
Products Balance
Are Income
Sheet
Produced Statement
Inventories
Manufacturing
Overhead

Period Costs
 The Behavior of Fixed
and Variable Costs
• As production volume changes, some costs may
increase or decrease and other costs may
remain stable.
• However, the predictability of specific costs to
change with volume provides an important tool
for managerial accountants.
 Fixed & Variable Costs
Fixed costs stay They vary when
the same in expressed on a per
total. unit basis.

Variable costs vary They are constant

in direct proportion when expressed as
to volume changes. per unit amounts.
 Step Costs

Some costs vary but only with relatively large

changes in production volume. Costs like these
are sometimes referred to as step costs.

Although step costs are technically not fixed costs,

they may be treated as such if they remain
constant within a relatively wide range of
production.
 The Cost Equation

Expressing the link between costs

and production volume as an
algebraic equation is useful.

The equation for a straight line is:

y = a + bx
 High-Low Method
Once the high and low volume points are identified,
we begin the calculation for variable costs.

Variable Cost Change in Cost

=
Per Unit
Change in Volume

Rs. 505,000 – Rs.337,500

=
2,600 – 1,200

=
Rs.119.5
 A Comparison of
Absorption Costing and Variable
Absorption
Costing
Costing
Variable
Costing
 A Summary of
Absorption Costing and Variable
Costing