Pre-Production Cost

Definition

Pre-production cost are economic resources forgone before a company is formally established or incorporated. It is any direct or indirect cost incurred to produce a dummy or prototype of a product before the actual product is produced. Pre-production cost are forgone economic resources in production of a product for testing purposes before the company goes commercial. These costs may include for example, all cost paid or incurred during mineral exploration, research and development costs, cash out flows, obligations and liabilities of either long term or short-term nature.

This type of cost should not be confused with preliminary costs or expenses in Financial Accountancy which may be affiliated to indirect costs such as administration or sales promotion incurred before the company or firm is established/incorporated. Since pre-production cost involve actual cash out flow before the normal business start, they are referred again to as fictitious assets and are written off at the end of the financial year.

For example, if the pre-production cost incurred to produce a dummy phone was $5000. This amount can be written off or amortized against profit and loss account within 5 years such that at the end of every financial year $1,000 is written off against the profit and loss account of the firm.

NB₁: Pre-production cost end up adding value to the product/or firm in question. This is the reason as to why this classification of cost is on the basis of firm value addition criteria.

NB₂: In any firm, whether small or large, there exists both pre-production cost and post-production cost where by the latter cost is any economic resources incurred in adding value to a product after the firm has been incorporated.

NB₃: For pre-production cost to be amortized, there is need to capitalize the amount of cost paid or incurred.

Scenarios Involving Pre-Production Costs

       ENGINEERING ASSIGNMENT/PROJECT

       Cost incurred or paid to carry out engineering activity such as building a bridge. In this case, costs paid for or incurred such as;

Advantages Of Pre-Production Cost

1. Improve quality of the final product
2. Appropriate in firm valuation especially during mergers and acquisition
3. Helps in correct pricing of the final product for all costs are already factored in
4. Help in Cost-Benefit analysis processes so as to assess the economic viability of projects.

Disadvantages Of Pre-Production Cost

1. Cumbersome to undertake for it involves extra
2. Not applicable to small firms especially for start-ups
3. Costly to maintain for additional cost of putting systems in place is a must.