Product costs

Product Costs and Period Costs
As examined in the Topic 3-4 background paper, businesses recognize costs having potential economic
benefits, such as materials and finished goods inventory, manufacturing equipment, and warehouse facilities in
their balance sheets as assets. In contrast, businesses recognize costs no longer having potential economic
benefits, such as the costs of products sold or the cost (salaries) of administrative employees’ services
provided, in their income statements as expenses. Businesses classify costs for financial reporting purposes7
as product costs or period costs.
 Product costs have a causal relationship to revenues a business recognizes (reports) in its current
income statement. As defined above, these are the costs of manufacturing products that a business sells
to its customers and include direct material, direct labor, and MOH costs. In general, businesses recognize
product costs as assets (inventory) in their balance sheets until they recognize related revenues from their
sale. When they recognize revenues in their income statement, businesses concurrently recognize the
related product costs as expenses (cost of goods sold, or cost of sales). In general, manufacturing costs
(defined above) represent product costs.
 Period costs are those for which a clear causal relationship with specific revenues earned by the business
does not exist. Period costs include R&D, employee training, and advertising costs. Businesses record
period costs as expenses in their income statement as they incur them, rather than as assets in their
balance sheets. Most nonmanufacturing costs represent period costs.
Both product costs and period costs (and both manufacturing costs and non-manufacturing costs) may include
allocated costs. Allocated costs include principally depreciation of long-lived property, plant, and equipment
(PP&E) and amortization of certain long-lived intangible assets (such as the cost of acquired patents or
licenses). For example, a business may depreciate equipment costing $100,000, having an estimated
economic life of 10 years and no estimated end-of-life salvage value, by recording $10,000 of depreciation in
each of those ten years. Depending on whether the business uses the equipment in its manufacturing or nonmanufacturing
activities, it will classify the related depreciation in each fiscal year as a manufacturingproduct
cost or as nonmanufacturing-period cost.

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