Product Cost Examples
All those costs that are incurred by a business entity in order to manufacture products and create services are known as product costs. The following Product Cost example provides an outline of the most common Product Costs.
Some of the common examples of product costs are –
- Direct Material Purchase
- Direct Labor
- Factory Overheads
Each example of the Product Cost in this article states the topic, the relevant reasons, and additional comments as needed.
Most Common Product Cost Examples
The following are examples of the product cost
Example #1 – Direct Material Purchase Budget
Direct Material Purchase Budget is required to create a product. The budget is required to calculate the amount of raw material that needs to be purchased for the production process and the estimation of the related costs.
Let’s say Raymond’s Pvt. Ltd, a small shirt manufacturing company requires fabric, thread, and buttons. Consider the direct raw material to be just fabric while the requirements of the other two materials cannot be directly tracked and hence considered as indirect.
The company targets to produce the following number of shirts in each quarter of the year. Data collected from the production budget:-
Raymond management collects the following details to create its direct raw material budget:
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- The cost of fabric is $80 per kilo. To manufacture a single shirt, the production department requires 500 grams (or 0.5 kg) of fabric.
- Management decides to store at least 10% of fabric for the following-quarter requirements of production
- At the beginning of the year (January-1), the opening value of the stock of fabric was 210 kilos.
- Assume the desired value of ending inventory is 250 kilos at the end of the year (quarter 4)
Use the following two accounting equations will help to create the budget:-
Ending Note: The product cost related to direct materials can be determined through a budget that estimates the desired quantity of direct material required for a period and its related costs.
Example #2 – Direct Labor Budget
Direct Labor Budget is required to estimate the labor force requirements in order to produce the required units of goods as per the production budget. It calculates the cost based on labor hours and units produced per labor.
Assume that in Raymond’s Pvt. Ltd:
- The time required by a sewing machine operator to stitch a single piece of shirt is 0.5 hours. Also, other labors to need 0.2 hrs per shirt for buttoning and finishing work.
- The company costs $50 per hour for a machine operator and a $15 per hour for other labors.
Ending Note: The Direct labor budget calculates the cost related to labor force engaged in the production process and estimates the required labor force in numbers. Thus management is able to anticipate hiring needs and budget its costs.
Example #3 – Factory Overhead Budget
The budget that includes every cost related to the production process other than costs relates to direct material and direct labor. The final costs determined as per the overhead budget are not capitalized under the balance sheet but get expensed in the income statement as cost of goods sold.
Also, the overall cost determined under the overhead budget is converted into per unit terms in order to determine the cost of ending inventory. The ending inventory becomes a part of the balance sheet.
The budget to factory overhead cost of Raymond’s Pvt. Ltd is presented in the following table:-
Ending Note: The factory overhead budget not only helped the management of the company to estimate the variable and fixed factory overheads separately but also helps in the determination of the required amount of cash to be disbursed in order to meet overhead expenses.
Example #4 – Product Cost Budget
The management of Raymond’s has estimated its costs to direct material, direct labor and factory overhead costs.
Now the most important step of the whole budgeting process is the determination of the overall product cost and determination of expected product cost per unit (shirt).
The management of the company adds all the components of cost together to reach the total product cost as presented below:-
Ending Note: The Product cost budget determines the overall expenses incurred by an entity in order to create a product on a periodical basis. The management can further calculate the cost per unit by dividing the estimated units to be produced as per the production budget.
By estimating the product cost per unit, the entity can set an appropriate sales price and avoid the situations of under-pricing or over-pricing its products. Both product under-pricing and overpricing bring losses to the entity.
- Under-pricing means the entity is charging less than the product cost -> Losses
- Overpricing leads customers to look for substitutes -> less demand -> Losses
In our example, Raymond’s management determines all the components of product cost viz. direct material costs, direct labor costs and factory overhead costs on a quarterly basis. With the help of this data, an overall product cost is determined on both quarterly as well as annual basis.
An average product cost per shirt of $103 is then determined by dividing the total annual product cost of $2.23 million by annual production of 21720 shirts. The company should charge an amount higher than $103 per piece of its shirts.
This has been a guide to Product Cost Examples. Here we provide you the top 4 practical industry examples of Product cost along with a detailed explanation. You can learn more about budgeting from the following articles –