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Costs may be classified as product costs and period costs.

This classification is usually used for

financial accounting purposes. A brief explanation of product costs and period costs is given below:

Product costs:
Product costs (also known as inventoriable costs) are those costs that are incurred to acquire or
manufacture a product. For a manufacturing company, theses costs usually consist of direct
materials, direct labor, and manufacturing overhead.
Product costs are initially treated as inventory and do not appear on income statement until the
product for which they are incurred is sold. When the product is sold, these costs are transferred to
cost of goods sold account. For example, if a company manufactures 50 units of product X and sells
only 30 units in 2013. The direct materials, direct labor and manufacturing overhead costs incurred to
manufacture these 50 units will be initially treated as inventory (an asset). The inventory of 30 units
will be transferred to cost of goods sold during the year 2013 and appear on the income statement of
2013. The remaining inventory of 20 units will not be transferred to cost of good sold in 2013.

Period costs:
The costs that are not included in product costs are known as period costs. Usually, these costs are
not part of the manufacturing process are, therefore, treated as expense for the period in which they
Period costs are not attached to products and company does not need to wait for the sale of products
to recognize them as expense. According to generally accepted accounting principles (GAAP), all
marketing, selling and administration costs are treated as period costs. Examples of these costs
include office rent, interest, depreciation of office building, sales commission and advertising
expenses etc.


2. The cost of a product consists of thefollowing cost components or elements:Direct

MaterialDirect LabourDirect ExpensesFactory OverheadSelling and Distribution
andAdministrative Overhead

3. Materials: Material indicates principal substancesused in production. Examples are:

cotton,jute, iron-ore, and silicon. The cost ofmaterial is further divided in to direct andindirect

4. Direct Material:Direct materials refer to the cost ofmaterials which become a major part
ofthe finished product. They are rawmaterials that become an integral partof the finished
product and areconveniently and economicallytraceable to specific units of output.Some
examples of direct materials are:raw cotton in textiles, crude oil to makediesel, steel to make
automobile bodies.

5. Indirect material:These are materials which are usedancillary to manufacture and cannot
betraced in to the finished product. Theseform a part of manufacturing overhead. Examples
are glue, thread, nails,consumable stores, printing and stationarymaterial

6. LABOUR: Labor is the physical or mental effortexpended on the production of an item. It

isthe active factor of production as againstmaterial which is a passive factor. The costof labor
further divided into direct andindirect labor.

7. Direct Labour:Direct labour is defined as the labourassociated with workers who are
engagedin the production process. It the labourcosts for specific work performed on aproduct
that is conveniently andeconomically traceable to end products.Direct labour is expended
directly uponthe materials comprising the finishedproduct. Examples are the labour ofmachine
operators and assemblers

8. Indirect labor: This includes wages paid for all labour which isnot directly engaged in
changing the shape orcomposition of raw materials. It cannot be traceddirectly to the product.
Lick indirect materials,indirect labour forms part of the manufacturingoverheads. Examples of
indirect labor cost arewages paid to foremen, supervisors, store-keepers, time-keepers,
salaries of officeexecutives and the commission payable to salesrepresentatives.

9. Direct Expenses:Direct expenses include any expenditure other thandirect material and
direct labor directly incurred on aspecific cost unit (product or job). Such specialnecessary
expenses can be identified with cost unitsand are charged directly to the product as part of
theprime cost.Some examples of direct expenses are: (a) Cost of special layout, designing or
drawings; (b) Hire of tools or equipment for a particularproduction or product; (c) Maintenance
costs of such equipments.

10. Indirect expenses: Indirect expenses are those incurred forthe business as a whole rather
than for aparticular order, job or product. Examplesof such expenses are rent,
lighting,insurance charges.

11. Overheads: Overheads may be defined as the aggregate of indirectmaterial, indirect labor
and indirect expenses. Thus, allindirect costs are overheads. These cannot be
associateddirectly with specific products. Hence, the amount ofoverhead has to be allocated
and apportioned to productsand services on some reasonable basis. The synonymous termis
burden. Overheads may be subdivided in to followinggroups: a)Factory overheads. b)
Administrative overheads. c) Selling and distribution overheads.

12. Factory Overhead:Factory overhead also calledmanufacturing expenses or factoryburden

may be defined as the cost ofindirect materials, indirect labor andindirect expenses. Examples
of such items arelubricants, cotton waste, handtools, works stationery.

13. Selling and Distribution andAdministrative Overhead: Selling and distribution overhead is
also known as marketing or selling overhead. Distribution expenses usually begin when the
factory costs end. Such expenses are generally incurred when the product is in saleable
condition. It covers the cost of making sales and delivering/dispatching products. These costs
include advertising, salesmen salaries and commissions, packing, storage, transportation, and
sales administrative costs. Administrative overhead includes costs of planning and controlling
the general policies and operations of business enterprises. Usually, all costs which cannot be

14. Fixed cost:Fixed cost is the cost which does not changein total for a given time period
despite widefluctuations in output or volume of activity.Example: Rent, Property taxes,
Supervisingsalaries, depreciation on office facilities,advertising, insurance etc.. Fixed cost can
be further classified into threetypes: Committed cost Managed cost Discretionary cost

15. Variable cost:Variable costs are those costs that varydirectly and proportionately with
theoutput. There is a constant ratio betweenthe change in the cost and change in thelevel of
output. Direct materials cost anddirect labor cost are the costs which aregenerally variable

16. Mixed cost:Mixed costs are made up of fixed andvariable elements. They are
combinationof semi-variable costs and fixed costs.

conversion costs

include all direct or indirect production costs incurred on activities that convert raw material to
finished goods. There are two main components of conversion costs, direct labor cost and
manufacturing overhead costs. Examples costs that may be qualify as conversion costs are wages,
rent, depreciation on plant and machinery, factory insurance, factory utilities, supervision, factory
repairs etc.
The term conversion cost is typically used in cost of production report of process costing where the
percentage of completion of partially manufactured units at the end of an accounting period is
typically same for direct labor and factory overhead. In such cases, it is time saving to calculate
equivalent units and unit costs by combining direct labor and factory overhead instead of doing
separate calculations for the two and theses two costs are termed as conversion costs.

Conversion Costs = Direct Labor + Manufacturing Overheads
Since total manufacturing costs has three components: direct material, direct labor and
manufacturing overheads, conversion costs may also be calculated using the following formula:
Conversion Costs = Total Manufacturing Costs Direct Material

Use the following information to calculate conversion cost per unit:

Completed Units
Direct Wages
Indirect Wages
Direct Material
Indirect Material
Equipment Depreciation
Office Expenses
Factory Insurance


Assume that there was no work in process inventory at the beginning and at the end of the
accounting period.
Direct Labor = 38,000
Factory Overhead
= 5,000 + 1,000 + 6,500 + 2,000
= 14,500

Conversion Costs
= Direct Labor + Factory Overhead
= 38,000 + 14,500
= 52,500

Conversion Cost per unit =

= $1.05

Explain controllable and uncontrollable costs.
Controllable Cost are the costs which can be influenced by the action of a specified member of the undertaking.
They are incurred in a particular responsibility centres can be influenced by the action of the executive heading
that responsibility centre. For example: Direct labour cost, direct material cost, direct expenses controllable by the
shop level management.
Uncontrollable Cost are the costs which cannot be influenced by the action of a specified member of the
undertaking. For example: a foreman incharge of a tool room can only control costs pertaining to the same
department and the matters which come directly under his control, not the costs apportioned to other department.
The expenditure which is controllable by an individual may be uncontrollable by another individual.