Explanation 1. Service company: Service companies are those companies which generate their revenues by selling intangible services rather than goods. These companies do not carry any inventories as they do not deal with tangible products. For e.g., marketing consultancy. It will not be carrying any physical goods to sell however it will provide services such as identification of target market, formulating marketing strategies for clients, advertising on the behalf of clients, brand positioning etc. For all the services rendered by the consulting company it will charge fees which will reflect as the revenue of marketing consultancy. It will incur expenses in terms of office infrastructure, advertising its services etc. These expenses will be termed as operating expenses. All of the expenses of a service company are period costs. Merchandising company: Those companies which buys products from the manufacturers or suppliers to resell are referred as a merchandising company. Merchandiser can be a wholesaler and a retailer. Wholesaler purchases products in a bulk and sell it to retailers and retailers sell them further to end users. These companies resell goods therefore they carry substantial inventory in their books. For e.g., departmental stores. These stores do not manufacture products, they procure it from the manufacturers and suppliers, mark up the prices and then sell their products. Manufacturing companies: Manufacturing companies are those companies which uses man, material, machine to convert raw material into finished goods. Manufacturers carry three types of inventory – raw material inventory, work in process inventory and finished gods inventory. For e.g., Furniture company. It will use raw material such as wood, paint, varnish etc. to manufacture different furniture such as bed, chairs, table. 2. Particulars Service company Merchandising company Manufacturing company Differences Nature of business It sells services It purchases goods from a manufacturer or supplier for reselling It uses man, material and machine to convert raw material into finished goods Inventory Carries no or minimal inventory Carries only one category of inventory Carries three different categories of inventory 1) raw material inventory, 2) work in process inventory, 3) Finished goods inventory Product cost It does not carry any inventory therefore no product cost. The cost incurred in purchasing the goods along with the cost incurred in getting the goods at the company's place of business Direct material, direct labor and manufacturing overheads are product costs Cost of goods sold There is no inventory therefore no cost of goods sold Cost of goods sold appears in the income statement Cost of goods sold appears in the income statement Similarities Period costs All the costs are period costs and mentioned in the income statement as operating expenses All the costs are period costs (except product costs) and mentioned in the income statement as operating expenses All the costs are period costs (except product costs) and mentioned in the income statement as operating expenses Table (1) 3. Value chain: A value chain is a set of activities which a company undertakes to add value to its products. There is a cost involved in all the activities across the value chain. Organizations needs to determine the cost incurred in different activities of the value chain to determine competitive selling prices. Activities which are involved in a value chain are research and development, design, production, marketing, distribution or customer service. Research and Development: Research and development (R&D) refers to those activities and processes whereby new or improved products or services are generated. It involves continuous research and development to identify new technologies or innovations to improvise products and service offerings. For example, companies are using artificial intelligence and robotics in their manufacturing process. Design: Design refers to a detailed plan which describes the layout or function of any object before it is manufactured. It describes in detail about the processes of producing any product or services. Part of design process also includes the means and techniques to increase the production volume. In order to achieve higher customer satisfaction companies, keep on designing new prototypes continually. Production or purchase: Production or purchase refers to the processes and methods used by manufacturers to transform various inputs into a finished goods or by merchandising company to purchase finished products for reselling. This activity in the value chain include all the costs which are incurred to produce or to obtain a product. The cost includes direct material, direct labor, manufacturing overheads. It also includes freight – in costs, import duties and tariffs which might incurred if the product was outsourced from outside. Marketing: Marketing refers to those activities in a value chain which are conducted to promote or sell products or services. This function is undertaken to create demand for the company’s products or services. Companies uses different ways of advertising and promoting their products to reach to the target audience. Distribution: Distribution involves those activities through which products or services are delivered to a large number of population. Companies uses different distribution channel to reach to the target audience such as retail shops, web-based sales platform, catalogue sales etc. Customer services: Customer service is a process to ensure that the customer needs are met by providing them with high quality services before, during and after the sale. Companies provides different services to ensue customer satisfaction such as free delivery, warranty and guarantee on products etc. The cost of the activities which are performed during research and development, design, marketing, distribution and customer service goes to the income statement. As cost incurred in these activities will be categorized as operating expenses. These expenses are the part of income statement and require to be factored to calculate operating income. The cost of the activities which are performed during production or purchase stage of value chain lows into inventoy in the balance sheet. These costs are incurred to obtain the finished product either through manufacturing or through merchandising. The finishd goods become the part of the inventory until it is sold. Once company sell finished good these cost becomes the part of the cost of goods sold. 4. Direct costs are those cost that can be identified with the cost object. Cost object refers to the specific project or facility or product. These costs are attributed to the specific goods or services. Direct cost can be classified as direct material and direct labor. Direct material is the primary material which becomes part of the finished good. These materials are directly identifiable with the finished products. For example, for an automobile manufacturer steel, tires, engine etc. would be considered as a direct material. Direct labor is a workforce which is directly involved in the production of goods and services. Direct labor cost is the cost of compensating these employees. For example, for an automobile manufacturer direct labor cost will involve the wages of machine operators who build and assemble the vehicles. Indirect costs are those costs which are also related to the cost object but cannot be traced to it. These costs are not attributed to specific goods and services. These costs are important cost in the production process and these costs are share by different cost object. Fo example depreciation of plant. This cannot be attributed to one job which is produced in a plant. Depreciation cost is shared by multiple jobs which have been produced in a plant during a specific period. Indirect cost can be categorized as indirect material, indirect labor and other manufcaturing overheads. Indirect material are those materials which are used in the production of goods or services but cannot be directly attributed to the finished good. For example, for an automobile manufacturer indirect cost will include janitorial supplies, oil and lubricants for the machine etc. Indirect labor is a workforce which is not directly involved in the production of goods and services. This is the cost of all employees working in the plant which does not include the cost of direct labor. Other manufacturing overhead includes all the other plant related costs. For example, for an automobile manufacturer other manufacturing overhead will include depreciation of plant or plant equipment, plant repairs and maintenance etc. Sometimes cost can be categorized as direct cost at one level but indirect cost at another level...