Product cost definition
/What is a Product Cost?
Product cost refers to the costs incurred to create a product. This cost can be used in several ways, either to report on the financial results of a business, or to make decisions about the viability of a product. Consequently, the accumulation of product costs forms a key element not only of an organization’s financial reporting, but also its management decision-making.
What is Included in Product Cost?
There are several classifications of costs that are included in product cost, which are as follows:
Direct labor. This is the cost of the employees directly involved in the production of goods. Direct labor can be substantial, when the underlying product requires a large amount of conversion work. In other cases, such as when components are simply being bolted together, it can be quite small.
Direct materials. This is the cost of the parts that go into a product. These materials may be built up from raw materials on-site, or they may be acquired in mostly-finished form from suppliers. The cost may include a reasonably-expected amount of scrap that is a byproduct of the production process.
Consumable production supplies. This is the cost of supplies that are consumed during the production process. This cost tends to be quite low, since it is comprised of such minor items as the oil and grease used on production equipment.
Factory overhead. This classification includes a large number of indirect production costs, such as the depreciation on production equipment, the cost of the materials management staff, the cost of electricity and other utilities in the production area, and the salaries of production supervisors.
Product cost can also be considered the cost of the labor required to deliver a service to a customer. In the latter case, product cost should include all costs related to a service, such as compensation, payroll taxes, and employee benefits.
Product Cost Reporting
Product cost appears in the financial statements, since it includes the factory overhead that is required by both GAAP and IFRS. However, managers may modify product cost to strip out the overhead component when making short-term production and sale-price decisions. Managers may also prefer to focus on the impact of a product on a bottleneck operation, which means that their main focus is on the direct materials cost of a product and the time it spends in the bottleneck operation.
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Product Cost Calculation
The cost of a product on a unit basis is typically derived by compiling the costs associated with a batch of units that were produced as a group, and dividing by the number of units manufactured. The calculation is:
(Total direct labor + Total direct materials + Consumable supplies + Total allocated overhead) ÷ Total number of units
= Product unit cost
Accounting for Product Cost
Product cost can be recorded as an inventory asset if the product has not yet been sold. It is charged to the cost of goods sold as soon as the product is sold, and appears as an expense on the income statement.
Terms Similar to Product Cost
Product cost is also known as product unit cost.
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