How To Record Product Development Costs
The product development process is the key to success for any business as it defines its distinction against its competitors. It enables them to build a product that customers would want and need. This process involves idea generation and screening, product concept creation, and product testing. If you can ensure the success of this process, you’ll be able to produce high-value products that boost your organization’s revenue.
However, this process can be time-consuming and might generate a lot of obstacles along the way. For instance, your team might not be able to record the expenses in the process, which might cause you to lose valuable money. Apart from that, you may also have trouble calculating your profit margin, preventing you from identifying how much sales or loss your business makes as you sell your latest invention.
To avoid these incidents, you must consider these tips in recording product development costs:
1. Identifying Direct Expenditures
Direct costs are the actual expenses incurred in the production of a product. You can identify and trace them back quickly to their source. For example, if an employee assembles product components for an hour, the salary paid for that hour would be a direct cost. Direct expenditures in product development may include the following:
- Research And Development (R&D): These expenses are related to the R&D process in developing your new product. R&D might include costs for prototyping and testing.
- Materials: This expense is directly related to the production of a new product and will vary based on how many parts are necessary for manufacturing. Aside from that, you also have to calculate the level of complication they are to produce.
- Direct Labor: This cost includes all labor hours associated with product development and can be broken down into specific areas such as engineering, quality control, and customer service.
- Equipment Purchases: refers to expenses related to purchasing equipment needed for production. For example, if your company purchases computers or other equipment used by employees developing new products, those expenses would be included in equipment purchase costs.
- Legal: Another category of product development costs is legal fees related to protecting intellectual property rights (IPRs). These expenses include patent application fees, tax services for business, and attorney fees associated with obtaining patents for new products or processes your company develops.
- Marketing: These are costs you incur in promoting your product before it’s ready for sale. These elements include advertising campaigns and any fee paid to external organizations that help boost your brand and sales.
- Sales: These expenses include any money spent on making sales calls, attending trade shows or conferences, hosting events, or paying commissions to salespeople who sell on behalf of your company. They can also include packaging, shipping, and handling costs associated with getting products from point A (manufacturing plant) to point B (customer).
It’s essential to take note of all of these expenses, along with the other costs below.
2. Determining All Indirect Expenses
Indirect costs cannot be directly attributed to a specific project or product. For example, renting and utilities are considered indirect costs if the company has an office. However, if the company rents office space to another company and collects rent, this rental income is regarded as direct revenue and should not be included as an indirect cost.
Recording all indirect costs can be a good practice because it provides a more realistic picture of the cost of developing products. If you only record direct costs and not indirect ones, your profit margins will look better than they really are because you aren’t taking into account all of the expenses related to creating your products. When you consider all fees when calculating your profit margins, you won’t get an inflated view of how much money you’re making on each product sold. Instead, you’ll get an accurate calculation of your profit margin and find cost-effective alternatives early on.
3. Looking For A Recording Platform
There are two leading platforms that you can use to record product development expenses, which include:
- Using A Product Cost Spreadsheet: A simple way to keep track of production costs is to use a spreadsheet program like Microsoft Excel or Google Sheets. You can create formulas that automatically calculate each row’s values based on the data you enter into other cells on the same worksheet. This technology makes it easy to compare multiple products at once and make changes as needed without having to retype all your data every time there’s an update.
- Leveraging Software Cost Tracking Tools: Consider using an accounting program if you’re looking for more advanced options. This software allows you to track each aspect of your business separately, including specific products. This technology makes it easier for you to track expenses relating to each product and compare one product against another when determining its profitability.
Choosing between the two would likely depend on how versed you are with the platform. If you think you can manage to operate software better than a spreadsheet, then choose the former.
4. Finding Recording Approaches
There are a variety of ways to record product development costs. The chosen approach will depend on the type of business, its accounting system, and the project’s complexity. To help you distinguish your options, below are the four approaches and their function:
- By Category Approach: If your company has a set of standard categories for recording product development costs, you can use those categories to track them. For example, if you’re developing software, you might record the expenses as “software research and development.” If you’re unsure how much money was spent on each aspect of the project, you’ll need to estimate those costs before entering them into your budgeting tool.
- Ad Hoc Basis: Recording product development costs on an ad hoc basis is the most flexible approach. It allows you to record expenses as they occur throughout the project’s duration. However, to use this method effectively, you’ll need to be diligent about tracking expenses and entering them into your budgeting tool as soon as possible after they occur. In doing so, you won’t forget about inputting expenses along the process, ensuring recording accuracy.
- Uniform Capitalization: The UNICAP method allows you to capitalize or depreciate certain expenses associated with developing an item. This alternative is used in software development and engineering industries, where a lot of research and development is involved. Unfortunately, remember that UNICAP is often effective if you manufacture products with a long lifespan. If you don’t, then consider other options to ensure recording success.
- Percentage Of Completion: Under this approach, you estimate how much of a product has been completed on a given date. After that, you’ll record an appropriate portion of all past and future product development costs in an asset account called ‘work in process.’
Then, the balance in this account is charged against products as they are completed at a predetermined percentage of their total estimated cost. This approach is used when future benefits cannot be reasonably estimated or when only some portion of the actual benefit is expected to be recovered through sales revenue.
As you can see, there are various recording approaches to track your product development costs. Choose one according to your needs.
5. Collecting Receipts For All Expenses
Gathering receipts for all product development costs is one of the most vital steps in recording expenses. In doing so, you’ll be able to create a record that you can use for future audits or disputes while minimizing the chance of errors. Aside from that, this strategy shows that your company follows good accounting practices to stay legally compliant.
As you collect receipts, you must assess the type of budgeting that you use. If you use a flexible budget, you need to track your spending accurately so that you don’t spend more than you planned. If you’re using a fixed budget, it’s still important to collect receipts so that you can calculate the actual cost of each project and determine whether your budget was too low or high.
6. Documenting The Product Development Timeline
The product development timeline is an important document that summarizes the critical stages of a product’s development. The timeline provides a visual summary of the events in the product development process and helps you understand where you are as you implement them. This graphic representation also enables you to identify potential issues with your project plan before they become problems.
So, as you record product creation expenses, you should document the different phases of each project and how long they took. Doing so ensures that if there are future delays with similar projects, you’ll be able to make adjustments in advance before they become costly surprises. For example, you may collect cost-related details if one phase took twice as long as expected due to unexpected problems with manufacturers. Then, use this information to ensure that future phases won’t suffer similar delays by providing better communication between departments.
The best way to document a product development timeline is to use a spreadsheet. In the platform, you’ll want to include each stage of the process and how long it took. For example, if you have three different design phases, you might want to track the time spent on each stage. After getting the data in place, you’ll be able to see where there may be issues in the development process while also getting error-proof records.
As you run an organization, you must be able to identify all the expenses incurred throughout all business processes to avoid over- or underestimation of budget. Therefore, you must consider following these six tips in documenting product development costs. Once you do so, you may avoid legal and cost complications as you go through the process by having all the records in the project.