Tuesday, April 2, 2013

Product Cost Opposed To Period Cost

Besides the distinction among manufacturing and non-manufacturing costs, there are other methods to look at costs. Costs can as well be classified as moreover product cost or period cost. To know the difference between product costs and period costs, we have to first refresh our understanding of the matching rule from financial accounting. Usually costs are known as expenses on the income statement in the period that benefits from the cost. For example, if a company pays for liability insurance in advance for two years, the complete amount is not measured an expense of the year in which the payment is made. In its place, one half of the cost would be known as an expense each year. The reason is that both years-not just the first year-advantage from the insurance payment. The un-expensed part of the insurance expense is carried on the balance sheet as a benefit called prepaid insurance. You should be recognizable with this type of accrual from your financial accounting coursework.

The matching principle is based on the accrual concept and states that costs incurred to generate particular takings should be recognized as expense in the same age that the revenue is recognized. This means that if a cost is acquired to acquire or make something that will ultimately be sold, then the cost should be recognized as expenditure only when the sale takes place-that is, when the benefit occurs. Such costs are called product costs.

Product Costs:

For financial accounting standards, product costs include all the costs that are engaged in acquiring or making product. In the case of manufactured goods, these costs are made of direct materials, direct labor and manufacturing overhead. Product costs are observed as "attaching" to units of manufactured goods as the goods are purchased or manufactured, and they remain attached as the goods go into inventory awaiting trade. So at first, product costs are assigned to an inventory account on the balance sheet. When the supplies are sold, the costs are free from inventory as expense (typically called Cost of supplies Sold) and matched alongside sales revenue. Since product costs are initially allocated to inventories, they are also known as inventorial costs. The purpose is to stress that product costs are not necessarily treated as expense in the period in which they are incurred. Rather, they are treated as expenses in the period in which the associated products are sold. This means that a product cost for instance direct materials or direct labor might be incurred during one period but not treated as an expense until a subsequent period when the completed product is sold.

Period Costs:

Period costs are the entire the costs that are not integrated in product costs. These costs are priced on the income statement in the era in which they are incurred; using the usual rules of accrual accounting that is part of financial accounting study. Period costs are not incorporated as part of the cost of purchased goods. Sales charges and office rent are good instances of period costs. Equally both items are expensed on the income statement in the period in which they are incurred. Therefore they are said to be period costs. 
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