From the course: Accounting Foundations: Cost-Based Pricing Strategies

Description of Export Clothing Company

From the course: Accounting Foundations: Cost-Based Pricing Strategies

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Description of Export Clothing Company

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- We're going to use an extended example to illustrate the computation of a production cost number that can then be used in a pricing decision. - Export Clothing, a hypothetical company, is a clothing exporter with a manufacturing plant in the Guangdong province of China. - The company produces both pants and shirts for the export market, with its major customers being large retailers in the United States. - Export Clothing makes both the shirts and the pants in the same production facility, but the workers specialize in making either shirts or pants. - Now the costs incurred in the production facility are as follows, as you'll plainly see here. In this list, the other manufacturing overhead item is composed of things such as factory rent, machine depreciation, production supervisors, and so forth. So let's take a quick dive into traditional cost accounting. Traditionally, costs are divided into two categories, product costs and period costs. Simply stated, product costs are those costs incurred in direct connection with the production facility, the shirts and pants facility in this case. Product costs are so named because the accounting system ties them to the costs of the products. They become part of the cost of the inventory. - These inventory costs flow through the system and then become the expense cost of goods sold when the inventory is sold to customers. - Now this $4,050,000 in costs is all product cost because these activities are directly associated with the work of the factory. There are also non-production costs associated with company headquarters. In this example, these headquarter costs are considered to be period costs. Period costs are those costs incurred in activities that are not directly connected with the shirts and pants facility. - These costs are not associated with the cost of producing the inventory, but are just reported as an expense in the period in which they occur. - Now this seems to be a crude approach to corporate headquarters costs. For example, isn't it possible that some of the headquarters staff work specifically on shirts issues, or pants issues? - That's a very good point. Here in this simple example, we'll use the traditional split of product costs and period costs. - Now later on we will mention another method of costing called activity-based costing, ABC, in which we take a more careful look at what activities actually cause these indirect overhead costs. Okay, here's some more detail about how the direct labor workers' time is split between the production of shirts and pants. And here is more detail of how the direct materials costs are divided between the shirts and the pants. During the year we've produced a total of 600,000 shirts, and the simple question we have is this, how much does it cost to make one shirt? Now why do we want to know? Because we've received an inquiry from a large retailer offering to buy shirts from us for $3.20 per shirt. And should we sell them? - Well first we'd better figure out how much it costs to make a shirt.

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