- Define and show examples of Product Costs
- Define and show examples of Period Costs
- Define and show examples of Prime Costs
- Define and show examples of Conversion Costs


[SLIDE 1]

We have discussed how costs can either be classified as direct or indirect in a previous lesson.  We have also discussed cost classifications related to a manufacturing company and how they can either be manufacturing or nonmanufacturing.  Let us now look at another way costs can be classified for an organization.  When preparing financial statements, we can classify costs in four different categories.  

These categories are:<ul>
<li>Product Costs</li>
<li>Period Costs</li>
<li>Prime Costs</li>
<li>Conversion Costs</li>
</ul>
We will discuss each one of these categories in more detail.


[SLIDE 2]

<strong>Product costs</strong> are all the costs involved in acquiring or making a product for resale to the consumer.  Each type of company has product costs. In manufacturing, these costs consist of direct materials, direct labor and manufacturing overhead.  For a retail company, this would be the cost of the products purchased for resale.  Service companies may include products, labor and charges for use of company equipment to perform work.

Product costs are linked to each unit of product purchased or manufactured, and remain there until the product is sold from inventory.

One thing to remember about product costs is that they remain on the balance sheet in inventory until the goods are sold.  Once the product is sold, this cost becomes an expense and is matched against sales revenue on the income statement.  In other words, the costs are not generally expensed in the period they are incurred but in a later period when the goods or services are sold.  


[SLIDE 3]

<strong>Period costs</strong> are all the costs that a company incurs that are NOT product costs.  These would include administrative salaries, rental costs of office space and equipment, advertising, sales commissions and other nonmanufacturing costs that are not part of the purchase or production of finished goods.  

These costs are expensed on the income statement in the period in which they are incurred.  Remember from financial accounting, this may not be the period in which the cash changed hands based on the rules of accrual accounting.  For example, insurance costs may spread across six months after the premium is paid and the excess is held in a prepaid account until the month the expense is used.


[SLIDE 4]

<strong>Prime cost</strong> is the cost category that is used when there are discussions of manufacturing costs. Prime cost is the sum of direct materials cost and direct labor cost.   

These costs are similar to the product cost except it does NOT include the overhead cost.  These costs are all direct manufacturing costs.  

When a company is reviewing their product costs, the greater the proportion of prime costs in their company's cost structure, the more managers can be confident in the accuracy of the costs of their products.


[SLIDE 5]

<strong>Conversion cost</strong> is another term that is used in manufacturing cost systems.  Conversion cost is the sum of direct labor and manufacturing overhead cost.  These costs are incurred when a company converts direct materials into finished products.  

One thing to note is that direct labor costs are a part of both prime costs and conversion costs.


[SLIDE 6]

As you can see so far, there are several cost terms that can be used to help management in planning, controlling and making decisions about a company's operations.  There are a few more which we will touch on in the next several lessons in this course.