What are Product Costs?

What are Product Costs?

Definition

Product costs are the expenses associated with producing the goods that a company makes or the services that it provides. These costs include direct labor, direct materials, and overheads.

What does product cost mean?

A firm that produces goods or provides services usually incurs the following types of expenses:

⇨ Direct material costs – these are the expenses for buying the raw materials that are used in the manufacturing process. A car factory, for example, would use steel, glass, and plastic to make cars.

⇨ Direct labor costs – this refers to the wages that are paid to an organization’s workers. A big car factory would employ hundreds or even thousands of individuals in the production process. A web design company would engage developers and other computer professionals. The costs incurred for these employees would be classified as direct labor costs.

⇨ Manufacturing overheads – certain expenses are not directly attributable to the products that are manufactured or the services that are provided to a customer. These include payments for rent, insurance, property taxes, and utilities.

All these costs, taken together, add up to the product cost.Direct material costs + Direct labor + Manufacturing overhead = Product cost

If the total product cost is divided by the number of units that are produced, the product cost per unit can be calculated. Of course, this is possible only if the organization is making just one type of product. If there are different products being manufactured, it would be necessary to allocate labor, material, and overhead expenses appropriately to arrive at unit costs.

Example of product cost

Maxime’s Boulangerie specializes in making bread. The firm incurs the following costs in 2017:

⇨ Wages for workers – $300,000

⇨ Flour, yeast, and other raw materials – $250,000

⇨ Rent and other expenses – $50,000

A total of 400,000 loaves of bread are produced during the year. The company’s total product cost is $600,000 ($300,000 + $250,000 + $50,000) and its per unit cost is $1.50 ($600,000 divided by 400,000).

Summary

Product costs are the total costs that are incurred in connection with producing a certain quantity of a good or in providing a specific service.