Question

Explain each of the following managerial accounting terms and provide a real life example for each accounting term: direct materials, direct labor, and manufacturing overhead (MOH). Explain why each accounting term is either classified as a product cost or period cost.

Answer 1

Direct material refers to the raw material that is used for producing the final product. The raw material will be directly involved and can be seen in the final product. Example - Wood is the raw material for making chairs and tables.

Direct labour refers to those employees who directly deal with the raw material for conversion into finished good. Example - Labour who work on wood for conversion into tables and chairs.

Manufacturing overhead are the costs that cannot be directly traced to the finished product like direct material and labor but are required for producing the finished product. Factory costs are known as manufacturing overhead. Example - Factory rent, depreciation on the machinery used for cutting wood or converting wood into chairs and tables, electricity expense for the machine used.

Direct material and labor costs are considered as product cost because these expenses increase with the increase in the production of the finished product. Example - More quantities of wood and more number of labor are required for producing more units of chairs and tables.

All manufacturing overhead are neither product costs nor period cost. Factory rent is a period cost because it is paid for every month irrespective of the number of chairs and tables produced. Electricity can be treated as product cost because this expenditure increases with the increase in the production of finished product. Electricity is actually semi variable. Depreciation on the machinery is again a period cost because it is calculated taking into account the useful life of the asset.