Question

1. Explain why product costs are capitalized but period costs are expensed in the current accounting period.
2. Explain how business activities and inventories for a manufacturing company, a merchandising company, and a service company differ.
3. Distinguish between direct labor and indirect labor.
4. Distinguish between (a) factory overhead and (b) selling and administrative overhead.
5. Distinguish between direct material and indirect material.
6. What product cost is both a prime cost and a conversion cost?

Answer 1

Solution. Product costs are the costs incurred during an accounting period encompassing organization's cost incurred into direct material, direct labor, supplies and overheads contributing to the making of the product and are capitalized as they are realized as a gain in future period. Whereas, period costs are the cost incurred on ongoing basis by the organization no matter what the sales volume is during the accounting period and so comes under expenses of current accounting period such as administrative costs.

A manufacturing company operates to convert raw materials procured to finished goods. In a merchandising company, finished goods are procured which has attained all levels of production completion, for reselling of the same in order to earn set profit. In a service company, organization delivers intangible transfer of benefits to its customers, there is non existence of inventory.

Direct labor encompasses labor unit cost which can be directly found from the unit cost of work on which it has been employed in the job, process or production of goods/service and included in prime cost and varies with varying levels of output volume and can be controlled. Whereas, Indirect labor is one which the management cannot easily determine and does not result into unit cost of work rather is employed indirectly for production activity and is included in organization's overheads cost.

Factory overhead is calculated by taking organization's indirect costs incurred during the production process while operating in an accounting period. Whereas, selling and administrative overhead are determined by the costs incurred after the production process, onto selling and administering processes of product's movement towards delivering its value to the customers.

Direct material costs refer to the expenses incurred directly onto production process of goods and services. Whereas, indirect costs are which are not easily ascertained and does not come under production process expenses.

Direct labor cost incurred during an accounting period onto production process of converting raw material into finished product for creating and satisfying customer value. It is one such product cost which comes under both the heads of prime cost and conversion cost.