Hello and welcome to chapter 2 part 2 this is Professor for hat in the previous session what we did the main topic was to differentiate between direct cost and indirect I'm sorry manufacturing cost and non manufacturing cost and just to just just as a quick reminder those are the manufacturing costs which is direct material direct .
Labor and manufacturing overhead and we talked about those cost and details in the previous recording then we have what's called non manufacturing cost selling an administrative sometimes it's called selling general and administrative well here we are on dealing with selling an administrative cost the next topic we're going to deal .
With in this chapter specifically is how we understand cost classification use to prepare financial statements so we need to know the difference between product cost and period cost so we need to differentiate between those two and this is when we prepare the financial statements so cost classification we have product cost and we have period .
Cost well what is product cost product cost include all the cost that is involved in acquiring or making a product ok what are the cost that are required to make a product okay that are involved in either acquiring or making the product ok well what do you acquire well if you're a few are manufacturing cars you need to acquire material ok .
Direct material is considered a product cost also you need to hire employees employees that work on in your facilities this is called direct labor so direct material and direct labor are considered product cost those are the cost that goes into the product also what goes into the product guess what Manufacturing overhead and what is .
Manufacturing overhead any cost other than direct material and direct labor that goes into manufacturing the product ok this is manufacturing overhead if you don't know what manufacturing overhead is please go back and view recording number 2 now what do we need to know about product costs so this is important so we .
Just say that's a product cost well this product cost here for financial statement is part of inventory so when we incur direct labor direct material and manufacturing overhead so what do we do with this cost let's assume we incurred just for just for the sake of illustration we and we we incurred 100,000 indirect labor and indirect and .
Direct material in a direct labor we incurred 50,000 in manufacturing cost and manufacturing overhead we incurred 250,000 so if we add labor material and overhead that's 150 that's 400,000 that's 400,000 so how do we classify this $400,000 that we incurred in making the product and making in acquiring and making the product this $400,000 sits in .
Inventory before the product is sold so this 400,000 is is considered an inventory cost okay so the product cost that sometimes it's called in some textbook it's called the inventory of all cost so that's the cost that sits on the balance sheet now let's assume we manufactured just for the sake of the example 40 core so with this 400,000 we .
Manufactured 40 cars okay so each card cost us $10,000 just for just I'm throwing this number out so just kind of I'm just gonna put I'm just gonna put this up here so we incurred $400,000 and we manufactured 40 cards so each car technically costs us $10,000 now we have an inventory basically we have 40 cards each at a cost of $10,000 okay so the .
The direct labor direct material and manufacturing overhead is now it's still considered an asset why because we still have those 40 cars sitting in our warehouse okay now what happened to the product cost well let's soon we're gonna sell these cars once we sell these scores what what's gonna happen to the inventory the inventory .
Turns into cost of goods sold let's assume we sold each car just for illustration purposes all we set assume we sold all 40 cars that assume we sold all 40 cars for half a million dollar half a million dollar suit so we made a $100,000 profit what's going to happen inventory let me just the kind of let's go back to the basic account some basic .
Accounting this way it's easier to see this so now we have inventory of $400,000 and we credit cash material whatever we spend whatever we spend etc for $400,000 so this is this is the debit and this is the credit and what did we do here we manufactured for 40 cards each card for $10,000 okay notice all the cash all the .
Material that we incurred all the payroll cash material just kind of remember we also paid employees just kind of remind you what goes into a product cost cash material payroll that's called inventory cost now what's going to happen so all this cost is basically this is an asset so basically the the inventory is an asset that sits .
On the balance sheet so this account here so now we have $400,000 in inventory if you don't believe me you can go outside and I can show you the 40 cars that we have parked so I can show you the asset that's why this is important to know that product cost is inventory cost and inventory is an asset so we have $400,000 worth of asset for .
Simplicity purposes let's assume we sold those 430 cars so now we have this kind of the assets we have 40 cars each at each cost us $10,000 now I'm going to sell these cards all in one shot for half a million so what I'm going to do and I'm going to also I'm going to sell them and receive cash just .
Keep this example simple so I'm going to debit cash half-a-million I'm going to credit sales half a million because I sold those cars now sold the I sold the forty cards now they know we no longer have them now what do we do with this inventory we no longer have the inventory the inventory is gone the inventory is going to turn into cost of .
Goods sold so now we're going to have cost of goods sold a 400,000 and we're going to credit inventory we no longer have the cars inventory of 400,000 and this is also an illustration of what we call the matching principle notice when we incurred the cost to manufacture those cars when we incurred the cost this is where we incurred the cost right .
Here I'm going to highlight this in yellow so in yellow is when we incurred the cost but notice when we incurred the cost the cost was an asset really all the material all the cash that we paid all the employees that we paid we kept this as an asset and what happened that this asset well once we sold the car at a later date in red those two entries in .
Red so we sold the cars and what happened to the inventory the inventory turned into cost of goods sold but in the process I hope hopefully you can see that we made $100,000 so let's go back to the PowerPoint slides so the point here to remember is inventory sits on the balance sheet until we sell it and once we sell it it turns into cost of .
Goods sold so let's clear the slide here okay so that's what happens where the product cost is well we need to compare product costs to a period cost well what is the period cost the period cost is something else period costs include all selling costs and administrative cost do you guys remember we talked about non manufacturing costs such as peer selling .
And administrative those are considered period costs so the question is what do we do with period cost how do we treat period cost okay for financial purposes for the financial statements what do we do very simple we will expense them we expense them okay so we expense the period cost immediately as they are incurred we expense them so now notice .
The product cost it's not expensed un
til it's sold so notice here the product costs we did not expense it until we sell it so this is the income statement so the product cost did not go on the income statement until it's sold okay so let me just show you how period costs work let's assume we incurred $500 and utilities expense so what we do is we .
Debit and utilities expense to heat the the office for the CEO for the administrative people so utilities expense $500 let's assume we paid cash keeping things simple cash is $500 okay let's assume we paid our sales sales the People v $15,000 sales commissions $50,000 in $50,000 cash $50,000 sales .
Commission expense so notice what we are doing is we are expensing everything that we are incurring those are let me just highlight them those are considered what those are considered let me just highlight them in a different color those are considered period costs why they are considered period cost because a few reasons why .
They are considered period cost one is there is no doors no there is no future benefit to those two those cost in other words once we incur the cost once we pay our utilities expense and the the administrative building there's no future benefit to that to that expense so basically we expense it remember the answer that's something .
That's going to provide future benefit well here when we pay the utilities expense in the manufacturing facilities we're going to recapture that cost when we sell the vehicles okay so that's why a sales commission utilities expense as well as many other the sales for the secretarial administrative assistant anything like this that is considered a .
Period cost okay so the period cost what is the what is the what's the goal to remember let me highlight about period cost the period cost is expense I highlight expense in red to remind you period cost is expensed so so this is the difference between a period cost and product cost let's see which of the following would be considered a period .
Rather than a product cost and manufacturing so which of the following are period okay is it manufacturing equipment depreciation well once you see them in the word manufacturing just be on the lookout most probably it's a product cost property taxes on corporate .
Headquarters well when once we see property taxes we need to know where are we paying the taxes is it on the manufacturing facilities or on the corporate headquarters notice here it's the corporate headquarter so what do you guys think we'll come back to that direct material cost what do you think .
Direct material cost is well direct material cost hopefully you know direct material cost is a manufacturing cost and manufacturing cost is a product cost electrical cost to light the production facilities once again production facilities we are talking about product cost okay this is where we are manufacturing the product sales .
Commissions what about sales commissions well when do sales commission occurs sales commission occur after we have manufactured the product so the product has been manufactured so it cannot be manufacturing cost so sales commission is surely a product a period cost what about property taxes on corporate headquarters well remember any cost .
That's incurred outside the manufacturing facilities is considered a period cost so property taxes if I told you property taxes on on manufacturing facilities then this will be a product that will be a product but now since it's not a product it is considered a period cost because the corporate headquarters the corporate headquarters .
Has nothing to do with what we are producing wherever we are producing another term to be familiar with which we're going to be using we're going to be using later you may see it most probably in a multiple-choice questions or down the road what you have to know you have to know immediately is this when we say prime cost .
Prime cost refer to direct material and direct labor and when we say conversion cost conversion cost is direct labor and manufacturing overhead conversion cost is basically what you need to convert the material into a product well what you need once you have the material you need labor and you need overhead that's why it's called the .
Conversion cost so you need to know conversion cost as direct labor and overhead cost and the prime cost the two prime costs that we need to manufacture something the two prime items are direct material and direct labor that's something you need to know by heart because in future chapters when they say conversion cost and prime cost they .
Don't define it they just assume at this point you know it okay the next topic is understand cost classification used to predict cost behavior which is an important topic that's going to stay with you throughout the throughout this course which include variable cost fixed cost and mixed cost and obviously I'm gonna I'm gonna I'm gonna devote one .
Whole session for this topic rather than blend it with product and period cost so the main topic that we cover the here is tune is you know you need to know the difference between what is a product cost and what is a period cost if you have any questions by all means please email me