Cost Behavior | Variable Cost | Fixed Cost | Mixed Cost | Period Cost | Product Cost |

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Product inventory for both manufacturing and merchandising firms is treated as an asset on their balance sheets. As long as the inventory has market value, it is considered an asset until the inventory is sold; then the cost of the inventory is transferred to the income statement as cost of goods sold. It is helpful, in understanding product costs for a manufacturer, to con- sider the value chain. The value chain of a manufacturer begins with the upstream activities of design, product development, and new product testing and then moves to manufacturing, followed by the downstream activities of distribution, sales, and customer service. The costs of the upstream and downstream activities are not product costs. Product costs for a manufacturing firm include only the costs necessary to complete the product at the manufacturing step in the value chain: 1. Direct materials. The materials used to manufacture the product, which become a physical part of it. 2. Direct labor. The labor used to manufacture the product. 3. Factory overhead. The indirect costs for materials, labor, and facilities used to support the manufacturing process. Product costs for a merchandising firm include the cost to purchase the product plus the trans- portation costs paid by the retailer or wholesaler to get the product to the location from which it will be sold or distributed. All other costs for managing the firm and selling the product are not product costs. They are expensed in the period in which they are incurred; for that reason, they are also called period costs. Period costs (nonproduct costs) include the general, selling, and administrative costs that are necessary for the management of the company but are not involved directly or indirectly in the manufacturing process (or, for a retailer, in the purchase of the products for resale). Advertising costs, data processing costs, and executive and staff salaries are good examples of period costs. In a manufacturing or a merchandising firm, period costs are also sometimes referred to as operating expenses or selling and administrative expenses. In a ser- vice firm, these costs are often referred to as operating expenses.