Production Costs

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What are the production costs?

Production or product costs refer to the costs incurred by a company to manufacture a product or provide a service. Production costs can include a variety of expenses, such as labor, raw materials, consumable manufacturing supplies, and overhead. Product costs may also include those incurred in connection with the delivery of a service to a customer. Government taxes or royalties owed by natural resource extraction companies are also treated as production costs.

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Production cost

Understanding production costs

For an expense to be considered a production cost, it must be directly linked to the generation of income for the business. Manufacturers bear the production costs of the raw materials and labor required to create the product. The service industries bear the production costs related to the labor required to implement the service and all material costs involved in providing the service.

Production has both direct and indirect costs. The direct costs for making an automobile, for example, would be materials like plastic and metal, as well as workers’ wages. Indirect costs would include overhead costs such as rent, administrative salaries and utility costs.

The total cost of products can be determined by adding the total direct costs of materials and labor as well as the total general manufacturing costs. To determine the cost of the product per unit of product, divide this sum by the number of units manufactured during the period covered by these costs.

Special considerations

Calculation of unit costs for product pricing

Data such as “cost of production per unit” can help you define an appropriate selling price for the finished item. To arrive at the production cost per unit, divide the production costs by the number of units produced. To reach equilibrium, the sale price must cover the unit cost. Prices above unit cost generate profits, while prices below unit cost cause losses.

If the cost of producing a product exceeds the selling price, producers may try to lower their production costs first. If they could not, producers could close their operations, temporarily or permanently. For example, in December 2020, the selling price of a barrel of oil fell to $ 45 per barrel. If oil production costs varied between $ 20 and $ 50 per barrel, a negative cash situation would occur for producers with high production costs. These producers could choose to stop production until selling prices return to profitable levels.

Production costs and asset registration

Once the product is finished, the company records the value of the product as an asset in its financial statements until the product is sold. Registering a finished product as an asset is used to meet the reporting requirements of the business and to inform shareholders.

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