Product cost

From CEOpedia | Management online

Product cost includes costs that are directly related to the product and a reasonable part of the costs indirectly associated with the production of this product.

A good cost estimation has a direct impact on performance and efficiency of a business enterprise. This may result in the loss of the company and goodwill on the market or large losses for the company. Cost estimation is the focal point of design and operational strategies and a key agenda for managerial policies and business. Also the client's satisfaction in terms of low costs, high quality and product delivery on time play a significant role [1].

Types of product costs

At the cost of producing the product (product cost) consists of the following items[2],:

  • direct materials
  • purchase costs,
  • own semi-finished products,
  • fuel and technological energy,
  • direct wages,
  • other direct costs.

Fixed vs. Variable Cost

Fixed cost - cost that the company incurs even during the period in which production is equal to zero. They remain unchanged (constans) for a wide range of activities over a period of time and may change over time, e.g. due to a change in macroeconomic conditions. Typical factors affecting the change in the level of fixed costs include, for example: changes in the organization of the enterprise, changes in the technology used, sales of machinery and production equipment

Variable cost - the cost the entrepreneur incurs for activities directly related to production. Resources that the company uses, for example: machinery, buildings or human resources [3].

Cost estimation techniques

  • Algorithmic technique
  • Fuzzy logic approach [4].

Examples of Product cost

  • Direct Materials: These are materials that are directly used in creating a product, such as the raw materials used to make furniture.
  • Direct Labor: This is the cost of the labor used to produce a product, such as the wages paid to employees who assemble furniture.
  • Manufacturing Overhead: This is the cost of indirect materials and labor used in creating a product, such as the cost of renting a factory to produce furniture.
  • Research and Development: This is the cost of researching and developing a product, such as the cost of researching and designing new furniture.
  • Packaging and Distribution: This is the cost of packaging and distributing a product, such as the cost of packaging and shipping furniture.
  • Advertising and Promotion: This is the cost of advertising and promoting a product, such as the cost of creating and running ads for furniture.
  • Support Services: This is the cost of providing customer service and technical support, such as the cost of providing customer support for furniture.

Advantages of Product cost

Product cost is a comprehensive accounting system that includes all the costs associated with a product’s production. There are several advantages to using product cost:

  • It provides a comprehensive view of a product’s costs, allowing businesses to more accurately assess the true cost of production and make informed decisions on pricing and production.
  • It provides a more accurate measure of profitability of a product, as it takes into account both direct and indirect costs associated with production.
  • It can help to identify areas of inefficiency and waste, allowing businesses to better manage resources and improve their bottom line.
  • It can help businesses to better understand their customer needs, as it allows them to accurately assess the cost of production versus the customer’s willingness to pay.
  • It can help businesses to better understand their competition, as it allows them to compare their own costs to those of their competitors.

Limitations of Product cost

Product cost has several limitations that should be considered when calculating the total cost of a product. These limitations include:

  • Difficulty accurately tracking indirect costs - Indirect costs, such as overhead, can be difficult to accurately track and allocate to a particular product. This can lead to inaccurate product costs that may not reflect the true cost of production.
  • Lack of visibility over variable costs - Variable costs, such as raw materials, labor and energy costs, can fluctuate over time, making it difficult to accurately assess the total cost of producing a product.
  • Ignoring opportunity costs - Opportunity costs, such as the cost of not investing in a new technology, are often not taken into account when calculating product cost. This can lead to an inaccurate assessment of the total cost of production.
  • Difficulty calculating the cost of quality - The cost of quality, such as the cost of inspecting products or the cost of disposing of defective products, is often not taken into account when calculating product cost. This can lead to an inaccurate assessment of the total cost of production.
  • Ignoring long-term costs - Long-term costs, such as the cost of warranty repairs or the cost of environmental compliance, are often not taken into account when calculating product cost. This can lead to an inaccurate assessment of the total cost of production.

Other approaches related to Product cost

One approach to product cost analysis is to consider the different types of costs that can be associated with a product. These can be broken down into:

  • Direct costs, which are associated with the costs related to the direct production of the product, such as materials, labor, and overhead costs.
  • Indirect costs, which are associated with costs that are not directly related to the production of the product, such as research and development costs, marketing costs, and legal costs.
  • Fixed costs, which are associated with costs that remain constant regardless of the amount of production, such as rent, insurance, and depreciation.
  • Variable costs, which are associated with costs that can fluctuate based on the amount of production, such as materials, labor, and overhead.
  • Opportunity costs, which are associated with the cost of not pursuing an alternative course of action, such as the cost of not investing in a new project or the cost of not taking advantage of a new market opportunity.

By analyzing these different types of costs associated with a product, companies can gain a better understanding of how much it costs to produce a product and how best to allocate resources in order to maximize product profitability. In summary, product cost analysis involves considering direct, indirect, fixed, variable, and opportunity costs associated with a product.


Product cost — recommended articles
Cost behavior — Step cost — Cost element — Added value chain — Absorbed costs — Hidden cost — Differential cost — Differential costing — Cost per unit

References

Footnotes

  1. ↑ Product Cost Estimation: Technique Classification and Methodology Review, MAY 2006, Vol. 128/ 563
  2. ↑ Direct materials deposition: designed macro and microstructure (1999)
  3. ↑ How cost accounting distorts product costs, Apr 1988, p.20
  4. ↑ Manufacturing cost modelling for concurrent product development, (2001) p.347

Author: Paulina Ściera

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