Product cost and direct material and direct labor cost are all related to the concept of product costing explains William D King. And each may be classified under different categories.
The allocating of indirect costs associated with the production of a particular good or service is called product costing. The purpose behind such allocation of costs is basically to arrive at a price for units sold (cost per unit). In most business organizations, this process of identifying the indirect effects on products helps in ascertaining the overall profitability as well as economic efficiency over a period of time.
If a company manufactures both A and B products then it will have to incur some amount on research and development for new technologies that can improve its production methods or quality levels or anything else that would create a competitive edge over the competitors. This R&D cost will be spread across all products manufactured by this company as it would be deemed as an indirect factor that affects them all. Doing so, however, assumes that there is no other way to achieve such a goal, and that makes tracking of these costs easier says, William D King.
In the absence of any better alternative, product costing also gives a good estimate of total manufacturing or service provider’s expenses i.e. indirect costs should not include those activities which are directly responsible for bringing in revenues to the organization concerned from its customers/clients/consumers, etc. In simple words, the term ‘indirect’ here refers to those internal or external factors which affect business indirectly but gets allocated proportionately to the products.
The product costing method may involve several other concepts like work in process (WIP), finished goods, and cost of goods sold (COGS).
The basic difference between product costing and job costing is that in the case of the former, the costs are associating with an entire production run while for the latter it is link to a specific job or project. For instance: in the case of construction work, it would be difficult to separate one house from another because they have been using similar methods whereas if we take into account software development activities then both jobs – designing and coding can treat as separate units. So, if any changes were made during the design phase. Then only the relevant portion will affect the coding activity which follows it i.e. The indirect costs will only reflect the changes that have been effecting during the design phase. Which then passes on to coding activity says, William D King.
Product costing practices help in creating a system of control over internal resources. That is quite similar to variable costing practices wherein the case of material usage or direct labor cost. It becomes easier to determine them for each job/product being handle by an organization. This practice also helps businesses in determining their break-even points at any point in time. Along with product pricing strategies. So as to derive maximum profits from their products without affecting their overall profitability factors negatively.
Consistency plays a major role when it comes to product costing. Because any deviation will result in deviation in overall profitability I e profit margins etc. Often companies are force to overcome the hurdles posed by by-products. Costing practices by developing certain accounting theories that would give more importance to consistency over accuracy. For example: let’s assume that the company produces two products A and B. With the same material used per unit output. But its distribution of indirect costs is not uniform across them.
At first glance, this might not seem like a problem at all. Because the main objective is to get an accurate price. For each unit based on total accumulated indirect costs (total indirect cost incurred divided by a number of units) for both these products. However, in the case of smaller manufacturing lots. It will be hard for this company to determine the final pricing of these products. Which could lead to excess inventory levels or even stocking which can hamper sales volume. So the ordering of larger lots will be favorable in such conditions. This way, companies can ensure that they are not losing sales due to smaller ordering sizes. Rather they incur higher costs of production because of larger lot sizes. Which might make it difficult to keep their prices attractive for consumers.
Product costing also helps in establishing better control over individual departments within an organization. By grouping them into product-based calculations. So as to determine which one has contributed most towards the overall profitability factor of a company says, William D King. It is often seen that different departments come up with variances/discrepancies between the actual expenses incurring. By them and those reflected on a monthly or quarterly basis e.g. If there is any difference between departmental performance reports and actual results. Then this would reflect poorly on the entire management’s credibility.
The purpose of product costing is to assist management in taking effective decisions. Regarding the overall profitability factor of an organization explains William D King. However, it would be incorrect to assume that product costing and job costing follow similar accounting procedures. Because they deal with different subjects and hence require different approaches too for their respective needs and requirements. Hence, we can say that these techniques are in use. As a sort of control system over internal resources involved in the production process. So as to ensure maximum operational efficiency at all times. The only difference between them is the fact that it is easier to determine both direct and indirect costs. Associated with products rather than jobs that represent smaller units within larger commercial/industrial projects.