Classification of Costs (Product Costs and
Period Costs) – Comprehensive Notes
Introduction
Cost classification is the process of grouping costs according to their nature and purpose. One
of the most important classifications in managerial and cost accounting is the distinction
between Product Costs and Period Costs. This classification helps managers determine the
cost of manufacturing products, calculate profitability, prepare financial statements, and make
business decisions.
Understanding the difference between product and period costs is essential because product
costs become part of inventory and are expensed only when goods are sold, whereas period
costs are charged directly against revenue in the period in which they occur.
1. Product Costs
Definition
Product costs are costs incurred to manufacture or acquire products. These costs are attached
to the product and become part of inventory until the goods are sold.
They are often referred to as inventoriable costs because they are included in inventory
valuation.
Components of Product Costs
Product costs consist of:
A. Direct Materials
Materials that become an integral part of the finished product and can be directly traced to it.
Examples:
● Wood used in furniture
, ● Steel used in automobiles
● Fabric used in clothing
● Flour used in bread production
B. Direct Labor
Labor costs of workers directly involved in manufacturing the product.
Examples:
● Machine operators
● Assembly line workers
● Carpenters making furniture
● Tailors producing garments
C. Manufacturing Overhead
All manufacturing costs other than direct materials and direct labor.
Examples:
● Factory rent
● Factory utilities
● Factory supervisors' salaries
● Factory insurance
● Depreciation of factory equipment
● Lubricants for machinery
● Factory maintenance supplies
Characteristics of Product Costs
1. Related directly to manufacturing.
2. Included in inventory valuation.
3. Recorded as assets until goods are sold.
4. Become Cost of Goods Sold (COGS) when products are sold.
5. Essential for determining production cost.
Accounting Treatment
When Incurred
Period Costs) – Comprehensive Notes
Introduction
Cost classification is the process of grouping costs according to their nature and purpose. One
of the most important classifications in managerial and cost accounting is the distinction
between Product Costs and Period Costs. This classification helps managers determine the
cost of manufacturing products, calculate profitability, prepare financial statements, and make
business decisions.
Understanding the difference between product and period costs is essential because product
costs become part of inventory and are expensed only when goods are sold, whereas period
costs are charged directly against revenue in the period in which they occur.
1. Product Costs
Definition
Product costs are costs incurred to manufacture or acquire products. These costs are attached
to the product and become part of inventory until the goods are sold.
They are often referred to as inventoriable costs because they are included in inventory
valuation.
Components of Product Costs
Product costs consist of:
A. Direct Materials
Materials that become an integral part of the finished product and can be directly traced to it.
Examples:
● Wood used in furniture
, ● Steel used in automobiles
● Fabric used in clothing
● Flour used in bread production
B. Direct Labor
Labor costs of workers directly involved in manufacturing the product.
Examples:
● Machine operators
● Assembly line workers
● Carpenters making furniture
● Tailors producing garments
C. Manufacturing Overhead
All manufacturing costs other than direct materials and direct labor.
Examples:
● Factory rent
● Factory utilities
● Factory supervisors' salaries
● Factory insurance
● Depreciation of factory equipment
● Lubricants for machinery
● Factory maintenance supplies
Characteristics of Product Costs
1. Related directly to manufacturing.
2. Included in inventory valuation.
3. Recorded as assets until goods are sold.
4. Become Cost of Goods Sold (COGS) when products are sold.
5. Essential for determining production cost.
Accounting Treatment
When Incurred
