Costs that are consumed and incurred during the production of a product, purchase of inventory, or performing a service are regarded as product costs. What exactly is the product cost? What are the types of product cost? How can you calculate it and record the same in a financial statement? These are discussed below.
Meaning of product cost
Product costs are costs incurred to manufacture a product or render a service. It is sometimes called production cost or manufacturing cost.
Types of the product cost
There are two types of the product cost
Expired product cost
This is the type of product cost in which revenue is already realized from it. Or that has been sold off. It is usually written off to the cost of sales and charged to the statement of profit or loss.
Unexpired product cost
This is the part of the product costs that are yet to be sold. Or in which revenue is yet to be realized from it. Unexpired product costs form part of the inventory of the firm. It is usually stated as closing inventory and posted to the statement of financial position.
How to calculate product cost
Product cost for a manufacturing entity is the combination of material cost, direct labor cost, direct expenses, and production overhead cost. The format for calculating and presenting product costs is provided in the table below.
If the total product cost is known, you can simply calculate product cost per unit with the formulae below.
Product cost per unit = Total product cost ÷ unit produced.
For example, if the total product cost calculated using the above format is 200,000 Naira, and the total units produced is 1,000 units. Using the formulae above, the product cost per unit is 200,000 ÷ 1,000. This gives a per-unit profit cost of 60 Naira per unit.
A worked example
HoneyBooks manufactured 2,000,000 units of books in a year. In 2019, the company cost for producing this unit was
Material cost. N280,000,000
Direct wages N98,000,000
Direct Expenses . N1,5000,000
Production overheads N62,000,000
Assuming a total of 1,700,000 units was sold for 250 Naira each, what is
1. The total product cost
2. Product cost per unit
3. Expired product cost
4. Unexpired product cost
5. Total revenue
6. State the journal entry for the cost of sales and closing inventory
7. Prepare the profit statement
The total product cost is presented in the table below
The product cost per unit is 441,500,000 ÷ 2,000,000 units. This gives 220.75 Naira per unit.
The expired product cost is 220.75 × 1,700,000 units. That is 375,275,000 Naira. This is the cost of sales.
The unexpired product cost is 220.75 × 300,000 (that is, the units unsold 20,000,000 – 17,000,000). This gives 66,225,000 Naira.
The addition of expired and unexpired product cost will give you the total product cost of 441,500,000 Naira.
The total revenue for HoneyBooks for the year 2019 is 250 × 1,700,000. This gives 425,000,000 Naira.
The journal entries are shown below
The profit statement is shown below
To conclude, product cost reflects the cost of manufacturing a product. It becomes the cost of sales (expired cost) and closing inventory (unexpired cost). Product cost computation is necessary for trading and manufacturing businesses.