What arguments can be advanced in favor of treating fixed manufacturing overhead costs as product costs? What arguments can be advanced in favor of treating fixed manufacturing overhead costs as period costs? Which arguments do you find to be the most valid? Explain.
To determine whether fixed manufacturing overhead costs should be treated as product costs or period costs, we need to understand the nature of these costs and consider the various arguments for each approach.
Fixed manufacturing overhead costs are indirect costs incurred in the production process that do not vary based on the level of activity, such as rent, utilities, depreciation of manufacturing equipment, and salaries of production supervisors.
Arguments in favor of treating fixed manufacturing overhead costs as product costs:
1. Matching principle: Treating fixed manufacturing overhead costs as product costs aligns with the matching principle of accounting. Since these overhead costs are incurred to support the production of goods, they should be allocated to the products produced during a specific period to determine their total cost. This allows for more accurate matching of costs with revenues.
2. Full-costing approach: Treating fixed manufacturing overhead costs as product costs reflects a full-costing approach to pricing products. Including fixed manufacturing overhead costs in the product cost calculation provides a more comprehensive view of the total costs incurred in producing the goods.
Arguments in favor of treating fixed manufacturing overhead costs as period costs:
1. Simplified allocation: Treating fixed manufacturing overhead costs as period costs simplifies the allocation process. Period costs are expensed in the period incurred, without the need for allocation to specific products. This reduces the complexity of allocating overhead costs and allows for easier analysis of period expenses.
2. Timeliness: Treating fixed manufacturing overhead costs as period costs provides more timely recognition of expenses. Since these costs are unlikely to directly influence the decision-making process related to specific product pricing, expensing them in the period incurred allows for more accurate financial reporting.
When considering the validity of these arguments, it depends on the specific circumstances and the nature of the business. The matching principle argument is generally considered strong because it emphasizes the accurate matching of costs and revenues to determine the profitability of each product. However, the simplified allocation and timeliness arguments for treating fixed manufacturing overhead costs as period costs can be valid for businesses with less complex overhead structures or where these costs do not significantly impact product pricing decisions.
Ultimately, the decision on whether to treat fixed manufacturing overhead costs as product costs or period costs should be based on a careful assessment of the specific business context, the nature of the overhead costs, and the reporting requirements and preferences of the stakeholders involved.