Product and Period Costs
Manufacturing companies have two very broad categories of costs: product and period costs.
Product Costs
Product costs are those costs required to be incurred in order to produce a product to be sold. Product costs will fit into one of three categories. Click on the tabs below to read more details about each category.
Direct Materials: These are materials that can be traced to an individual product. For example, when producing clothing, the company knows exactly what it spent on the materials placed into each individual shirt, pant, etc. These are direct materials.
Direct Labor: This is time spent that can be directly traced to an individual product. Using the clothing company again, you can assign a cost to a shirt based on exactly how long an employee worked on that individual shirt. If she works on the shirt for an hour and makes $15.00 an hour, the direct labor cost is 15 x 1 = $15.00.
Factory Overhead: This is the final type of product cost, and is a little more difficult to assign. By definition, factory overhead is the cost needed to produce a product but that cannot be directly traced to an individual product. This includes items such as utilities and depreciation on the factory, indirect materials and labor, property taxes on the factory, and many more expenses. Think about this: could you produce the shirts in the clothing company without electricity to run the machines and the lighting to see? Probably not, so they are a product cost. But how much of the electric bill should be assigned to one t-shirt? That is impossible to do with certainty. The topic of assigning overhead costs to products will be discussed extensively in a future lesson.
Period Costs
The other costs manufacturing companies incur are period costs. These costs have nothing to do with the manufacturing of the actual product. This will include things like accounting, sales, utilities of an office building, etc. These costs are certainly needed to become a profitable company, but they are not needed to actually produce the product. Because they have nothing to do with the product, period costs are expensed as incurred, as opposed to entering an inventory and ultimately as COGS.
