Question:
A manufacturing company prepays its insurance coverage for a three-year period. The premium for the three years is $2,700 and is paid at the beginning of the first year. Eighty percent of the premium applies to manufacturing operations and 20% applies to selling and administrative activities. What amounts should be considered product and period costs respectively for the first year of coverage?
Product/ Period
a) $2,700 $0
b) $2,160 $540
c) $1,440 $360
d) $720 $180
a. Option A
b. Option B
c. Option C
d. Option D
Answer:
The correct answer is D.
Explanation:
Definition of Terms:
Product Cost is defined as the costs involved in creating a product. These costs include materials, labor, production supplies and factory overhead. ..Product costs related to services should include things like compensation, payroll taxes and employee benefits.
It may also include insurance on the building, and repairs and maintenance on the building and machinery.
Period Cost is defined as expense items that will be entered onto the income statement without ever attaching or relating to products or services. Instead, period costs will be referred to as period expenses since they will be reported on the income statement as selling, general and administrative (SG&A) or interest expenses.
Given the above,
Step 1
To determine Product Cost for the first year,
We divide annual insurance premium by number of years paid for.
Annual insurance expense = $2,700 ÷ 3 = $900
Step 2: Derive the amount payable as product cost.
Portion applicable to Product cost = Percentage applicable to manufacturing multiplied by annual insurance premium:
=0.80 × $900 = (0.80) × $900 = <u>$720 </u>
Step 3
Portion applicable = Portion applicable to selling and administrative activities multiplied by annual premium amount.
= 0.20 × $900 = <u>$180</u>
The product and period costs are thus given as $720 and $180 respectievely.
Cheers!
