• Direct Materials - are those materials that become an integral part of the finished product and
whose costs can be conveniently traced to the finished product.
o raw materials - materials that go into the final product. Any materials that are used in the final
product; and the finished product of one company can become the raw materials of another
company. Raw materials may include both direct and indirect materials.
o indirect materials - Small items of material such as glue and nails that may be an integral part of
a finished product, but whose costs cannot be easily or conveniently traced to it.
• Direct Labor - factory labor costs that can be easily traced to individual units of product.
o indirect labor - The labor costs of janitors, supervisors, materials handlers, and other factory
workers that cannot be conveniently traced to particular productr, or that can be traced only at
great cost and inconvenience. Just like indirect materials, indirect labor is treated as part of
• Manufacturing Overhead - all manufacturing costs except direct materials and direct labor.
Manufacturing overhead includes items such as indirect materials; indirect labor; maintenance and
repairs on production equipment; and heat and light, property taxes, depreciation, and insurance on
manufacturing facilities. Only those costs associated with operating the factory are included in
Nonmanufacturing Costs (selling and administrative costs)
• Selling costs - All costs that are incurred to secure customer orders and get the finished product or
service into the hands of the customer. These costs are sometimes called order-getting and order-
filling costs. Examples: advertising, shipping, sales travel, sales commissions, sales salaries, and costs of
finished goods warehouses.
• Administrative costs - All executive, organizational, and clerical costs associated with the general
management of an organization rather than with manufacturing or selling. Include all costs associated
with the general management of an organization rather than with manufacturing or selling. Examples of
administrative costs include executive compensation, general accounting, secretarial, public relations,
and similar costs involved in the overall, general administration of the organization as a whole.
• Product costs - all costs that are involved in acquiring or making a product. In the case of manufactured
goods, these costs consist of direct materials, direct labor, and manufacturing overhead. Product costs
“attach” to units of product as the goods are purchased or manufactured, and they remain attached as the
goods go into inventory awaiting sale. Product costs are initially assigned to an inventory account on the
balance sheet. When the goods are sold, the costs are released from inventory as expenses (typically
called cost of goods sold) and matched against sales revenue. Because product costs are initially
assigned to inventories, they are also known as inventoriable costs.
• Period costs - Costs that are taken directly to the income statement as expenses in the period in which
they are incurred or accrued. are all the costs that are not product costs. All selling and administrative
expenses are treated as period costs. For example, sales commissions, advertising, executive salaries,
public relations, and the rental costs of administrative offices are all period costs. Period costs are not
included as part of the cost of either purchased or manufactured goods; instead, period costs are
expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting. Keep in mind that the period in which a cost is incurred is not necessarily the period
in which cash changes hands.
Prime Cost and Conversion Cost
• Prime cost - the sum of direct materials cost and direct labor cost.
• Conversion cost - is the sum of direct labor cost and manufacturing overhead cost. The term conversion
cost is used to describe direct labor and manufacturing overhead because these costs are incurred to
convert materials into the finished product.
• variable cost - varies, in total, in direct proportion to changes in the level of activity.Avariable cost is
constant per unit. Common examples of variable costs include COGS for a merchandising company,
DM,, DL, variable elements of manufacturing overhead, such as indirect materials, supplies, and power,
and variable elements of selling and administrative expenses, such as commissions and shipping costs.
• For a cost to be variable, it must be variable with