Please explain the connection between Product Costs and Cost of Goods sold? Wher
ID: 2732403 • Letter: P
Question
Please explain the connection between Product Costs and Cost of Goods sold? Where do period costs appear on an income statement? Finally, why do we call them period costs? Why do we go through all the trouble (and it can be a lot of trouble) to keep these costs separate?
Why do we need another format for the income statement? What's the purpose of the contribution margin income statement? When would it be used? I've seen annual reports and I've never seen one used. Why not?
Also, can anyone think of an example of a mixed cost in their personal life? There are a lot of them.
Explanation / Answer
1. Connection between Product Costs and Cost of Goods sold :
Product costs are all such costs that form part of the inventory.These are basically such costs that relates directly to the products such as direct material costs, direct labour costs manufacturing overheads, carriage inwards and all such costs that contributes and are necessary to bring the inventory to their present location and condition.
Cost of goods sold on the other hand is the product cost of goods sold in a particular accounting period or simply sum of inventoriable costs that has been expensed out in a specific accounting period.
2. Period Cost
A period cost is any cost that cannot be capitalized into prepaid expenses, inventory, or fixed assets. A period cost is more closely associated with the passage of time than with a transactional event. Since a period cost is essentially always charged to expense at once, it may more appropriately be called a period expense.
Period costs appears on an income statement
Under the accrual method of accounting, period costs such as selling, general and administrative expenses are reported on the income statement in the accounting period in which they are used up or expire. They are referred to as period costs because they are not assigned to products, and therefore cannot be included in the cost of items held in inventory.
If a selling, general and administrative (SG&A) expense is prepaid, the prepaid portion will be reported as a current asset. When the prepaid expense expires, it will move to the income statement and become part of that period's SG&A expenses
Purpose of Contribution Margin Income Statement :
A contribution margin income statement is an income statement in which all variable expenses are deducted from sales to arrive at a contribution margin, from which all fixed expenses are then subtracted to arrive at the net profit or loss for the period. Thus, the arrangement of expenses in the income statement corresponds to the nature of the expenses. This income statement format is a superior form of presentation, because the contribution margin clearly shows the amount available to cover fixed costs and generate a profit (or loss).
It is useful to create an income statement in the contribution margin format when you want to determine that proportion of expenses that truly varies directly with revenues. In many businesses, the contribution margin will be substantially higher than the gross margin, because such a large proportion of its production costs are fixed, and few of its selling and administrative expenses are variable.