Period Costs Definition, Example, vs Product Costs

When preparing financial statements, companies need to classify costs as either product costs or period costs. We need to first revisit the concept of the matching principle from financial accounting. A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses.

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If advertising happens in June, you will receive an invoice, and record the expense in June, even if you have terms that allow you to actually pay the expense in July. The cash may actually be spent on an item that will be incurred later, like insurance. It is important to understand through the accrual method of accounting, that expenses and income should be recognized when incurred, not necessarily when they are paid or cash received. In managerial and cost accounting, period costs refer to costs that are not tied to or related to the production of inventory. Examples include selling, general and administrative (SG&A) expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office.

The timing of product costs

• Period expenses are costs that help a business or other entity generate revenue, but aren’t part of the cost of goods sold.
• Period costs are like the backstage crew ensuring the business show runs smoothly.
• This freight cost reflects a selling/distribution expense rather than a production expense.
• Most period costs are considered periodic fixed expenses, although in some instances, they can be semi-variable expenses.
• Liabilities are normally things that are settled over time through the transfer of money, goods, or services.

Properly categorizing period vs product costs gives businesses clearer visibility into production efficiency and profitability. It is important to keep track of your total period cost because that information helps you determine the net income of your business for each accounting period. The one similarity among the period costs listed above is that these costs are incurred whether production has been halted, whether it’s doubled, or whether it’s running at normal speed. Period costs are the costs that your business incurs that are not directly related to production levels. These expenses have no relation to the inventory or production process but are incurred on a regular basis, regardless of the level of production. An understanding of period costs helps you analyze your financial statements.

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Product costs include direct materials, direct labor, and overhead expenses. These costs are capitalized as inventory and become part of the cost of goods sold when the product is sold. If a company’s management understands both product and period costs, they can use it in improving decision-making. Product costs help businesses figure out how much it truly costs to make each item they sell, helping set prices for profit.

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For example, the wood and fabric that goes into a chair, or the wages of the worker assembling it. Overhead covers indirect production costs like electricity, equipment maintenance, factory supervision, insurance, and more. Overhead cannot be directly linked to individual units and is allocated based on an appropriate cost driver.

Difference Between Product Costs and Period Costs

The person creating the production cost calculation, therefore, has to decide whether these costs are already accounted for or if they must be a part of the overall calculation of production costs. Period costs and product costs are two categories of costs for a company that are incurred in producing and selling their product or service. Integrate financial data from all your sales channels in your accounting to have always accurate records ready for reporting, analysis, and taxation.

Product costs like materials are included in inventory valuation through cost of goods sold when production occurs. Other examples of period costs include marketing expenses, rent (not directly tied to a production facility), office depreciation, and indirect labor. Also, interest expense on a company’s debt would be classified as a period cost.

Imagine your favorite bakery – the cost of flour, sugar, and the baker’s time to make those croissants you’re so fond of. Freight costs can be categorized as either a product cost or a period cost, depending on the context. Product costs are used to calculate cost of goods sold and inventory value.

• Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities.
• Product costs are always considered variable costs, as they rise and fall according to production levels.
• Also, interest expense on a company’s debt would be classified as a period cost.
• The cash may actually be spent on an item that will be incurred later, like insurance.
• Period costs immediately expense themselves, appearing on the income statement for the specific period they occurred.
• Period expenses are important to know about because they can have a direct impact on both reducing costs and increasing revenue.

• In a manufacturing organization, an important difference exists between product costs and period costs.
• The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
• Product costs help you set these prices, ensuring you cover all the expenses and have some left for profit.
• Keeping track of the period of cost is also important for filing accurate business taxes and for preparing for an audit.
• The software development lifecycle is time-consuming, and you may face obstacles that could lengthen your timeline.
• Following accounting standards, the cost of inventory, or cost of goods sold, is any cost incurred to get inventory ready to be sold.
• Unlike period expenses, operating expenses often cannot be easily identified by when payments are received or made during the accounting periods that they affect.

Understanding the key differences between period costs and product costs is critical for strategic management accounting and decision making. For a bakery, the costs of ingredients and baking supplies that go into making their baked goods are considered product costs. Their general shop lease, utilities, and owner’s salary are period costs.