In accounting, we define the product cost as the direct material, direct labor, and manufacturing overhead.

Costs
such as advertising, preparing invoices, delivery expense, office salaries, office rent and utilities, and interest on
loans are examples of expenses that are not considered to be product costs. Rather, these costs are expensed
immediately to the period instead of being assigned to a product.
To be profitable, a company must have its selling prices large enough to cover both the product costs of the units
sold and the period expenses.
The product cost is used for valuing the inventory and for determining the cost of goods sold. Since some of the
manufacturing overhead costs are fixed in total (factory rent, factory depreciation, factory managers' salaries), the
per unit cost of a product will depend upon the number of units manufactured during a given year. In other words,
the cost of a product is not know with precision, even though accountants will compute the per unit cost to the
nearest penny.

Determining Product Costs and Other Costs in BusinessAll businesses that sell products must know their
product costs — in other words, the costs of each and every item they sell. Companies that manufacture the products
they sell — as opposed to distributors and retailers of products — have many problems in figuring out their product
costs.Most production (manufacturing) processes are fairly complex, so product cost accounting for manufacturers is
also fairly complex; every step in the production process has to be tracked carefully from start to finish.Many
manufacturing costs cannot be directly matched with particular products; these are called indirect costs. To arrive at
the full cost of each product manufactured, accountants devise methods for allocating indirect production costs to
specific products. Surprisingly, generally accepted accounting principles (GAAP) provide very little authoritative
guidance for measuring product cost. Manufacturing businesses have more than a little leeway regarding how to
determine their product costs. Even businesses in the same industry — Ford versus General Motors, for example —
may use different product cost accounting methods.

Accountants determine many other costs, in addition to product costs:

 The costs of departments, regional distribution centers, and other organizational units of the business
 The cost of the retirement plan for the company’s employees
 The cost of marketing programs and advertising campaigns
 The cost of restructuring the business or the cost of a major recall of products sold by the business, when
necessary

Cost accounting serves two broad purposes: measuring profit and providing relevant information to managers for
planning, control, and decision-making.The phrase actual cost often gets tossed around without a clear definition.
An actual cost depends entirely on the particular methods used to measure the cost. Many arbitrary choices are
behind every cost number you see. There’s no one-size-fits-all definition of cost, and there’s no one correct and
“best-in-all-circumstances” method of measuring cost.The conundrum is that businesses need exact amounts for
costs. In order to understand the income statement and balance sheet that managers use in making their decisions,
they need to understand a little bit about the choices an accountant has to make in measuring costs. Some cost
accounting methods result in conservative profit numbers; other methods boost profit, at least in the short run.

PRODUCT COSTProduct costs in managerial accounting are those that are necessary to manufacture a product.
Product costs equal the sum of your direct materials costs, direct labor costs and manufacturing overhead costs.
Using the actual costing method, you can determine your small business’s overall product costs and product costs
per unit based on the actual costs you incurred during a period. Knowing your product costs can help you price your
products and budget your small business's money.

Direct Materials
Direct materials are the materials your small business uses to manufacture a product that you can trace directly to the
product.

Direct Labor:Direct labor costs are the total costs you incur to employ the workers that directly assemble or
manufacture your products. These costs include wages, payroll taxes, pension contributions and
contributions for life, health and worker’s compensation insurance. Add together these costs you incurred for
the month to determine your total direct labor costs.

Manufacturing Overhead:Manufacturing overhead costs are those necessary to making a product, but that
you cannot trace directly to a specific product. Examples include indirect materials, such as masking tape,
and indirect labor costs, such as the costs to employ a maintenance worker. Examples of other overhead costs
are property taxes, rent and utilities. Add together each manufacturing overhead cost you incurred during
the month to determine total manufacturing overhead costs.

Product Cost and Product Cost per Unit Add together your total direct materials costs, your total direct
labor costs and your total manufacturing overhead costs that you incurred during the period to determine
your total product costs. Divide your result by the number of products you manufactured during the period
to determine your product cost per unit. Using the numbers from the previous examples, add together
$15,000, $3,200 and $5,000 to get $23,200 in total product costs. Assume you manufactured 200 bicycles
during the same period. Divide $23,200 by $200 to get a product cost per unit of $116.