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Distinguishing Financial Concepts

Your company, a medium-sized manufacturer of widgets, has just held the annual end of year "State of the Business" meeting for all employees. The president discussed how well the company has been doing, focusing on presenting the Income Statement for the last year. During the meeting, he used terms like product costs, and period costs, and how each affects the company's profits. He also announced that going forward, instead of manufacturing just one standard type of widgets, there will be a new department added that will make custom versions of the firm's normal product line.

At the end of the meeting, he asks each supervisor to prepare a memo to his or her own employees, describing in layman's terms the following concepts:

1. What are the differences between product and period costs?
2. Why is it important to properly distinguish one type of cost from the other?
3. Where on the firm's income statement will period costs usually show up?
4. Where on the firm's income statement would product costs end up?
5. The new department will make use of a job order costing system. How and why will this differ from the current process costing system used elsewhere in the plant?

Provide 2 examples of companies that would use:
1. Job order costing
2. Process costing

Solution Preview

For a manufacturing firm, like the one in the example, a product cost is a manufacturing cost while a period cost is a non-manufacturing cost. Some examples of product costs are direct material used in production, direct labor used in production, and manufacturing overhead (which are the indirect manufacturing costs). Period costs include all other costs of running the manufacturing firm. Some examples are, accounting costs, sales costs, and marketing costs.

It is important to distinguish the cost of producing the products from the other costs of running the business. The Product costs are the costs of producing the product. Determining the cost of ...

Solution Summary

The solution distinguishes between Product Costs and Period Costs; explains why it is important to properly distinguish between the two types of costs; and shows where in the income statement each type of cost would appear. The solution also distinguishes between process costing and job costing, and ends with a discussion on the types of companies that would use job costing and process costing.