Question

How does product costing used in financial accounting differ from product costing used in managerial accounting?

Answer 1

Product cost refers to the costs incurred to create a product. These costs include direct labor, direct materials, consumable production supplies, and factory overhead. 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.

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

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.

Product cost appears in the financial statements, since it includes the manufacturing 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.