Product Pricing

In order to adequately price a product, whether it be a manufactured good or provided service, firms must correctly link their costs with their products that are produced. Costs are split into two main groupings; product costs and period costs.[1] Product costs are directly related to the production of the good or service. These costs are initially assigned to inventory and thus represent an asset on the income statement. Once the product is sold, the costs are expensed using an account named Cost of Goods Sold. Period costs, on the other hand, are not directly associated with the manufacturing of the product. These costs are expensed in the same period as they are incurred. While period costs include marketing, selling, and administrative costs, product costs are split into direct materials, direct labor, and manufacturing overhead (See Appendix I for the definitions of these costs).[2]

In order to keep track during the product costing process, the costs that share a certain type, department, or responsibility are grouped together into cost pools. Each cost pool, in turn, has a particular cost driver that determines the total cost depending on the level of activity or volume used.[3] Finally, a cost object “can be a product, service, process or any item which management requires cost information”.[4]

The total cost of a product consists of two different cost classifications; fixed and variable costs. Fixed costs do not vary with increases or decreases in activity or volume levels. Examples of fixed costs would be facility costs such as property taxes and utilities as well as support activities like office supplies expenses. Variable costs vary in relation with the change in the cost driver of that cost pool. These costs include direct labor and direct materials.[5]

When it comes to tying the costs to their cost pools or cost objects, costs can either be assigned or allocated, depending on their nature. Direct costs are easily traced or assigned to their... [continues]

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