Product vs Period Costs Accounting for Managers

On the other hand, in Marginal Costing only the variable cost is regarded as product cost. An example of such cost is the cost of material, labour, and overheads employed in manufacturing a table. If that reporting period is over a fiscal quarter, then the period cost would also be three months. If the accounting period were instead a year, the period cost would encompass 12 months. Also, fixed and variable costs may be calculated differently at different phases in a business’s life cycle or accounting year. Whether the calculation is for forecasting or reporting affects the appropriate methodology as well.

Period Costs

Ending inventory is like a treasure trove of products waiting to leave the shelves and go to customers. The product costs, including direct materials, labor, and overhead, are like the guardians of this treasure. They determine the value assigned to these unsold goods on the balance sheet.

Administrative activities are the most pure form of period costs, since they must be incurred on an ongoing basis, irrespective of the sales level of a business. Selling costs can vary somewhat with product sales levels, especially if sales commissions are a large part of this expenditure. An example of a product cost would be the cost of raw materials used in the manufacturing process.

When costs are traceable to products and services, they are undeniably product costs. Being traceable means that you won’t have a hard time determining the physical quantity and its cost equivalent. Overhead, or the costs to keep the lights on, so to speak, such as utility bills, insurance, and rent, are not directly related to production. However, these costs are still paid every period, and so are booked as period costs. Many employees receive fringe benefits paid for by employers, such as payroll taxes, pension costs, and paid vacations.

Period Costs Examples: From Advertising to Rent

Product Cost is the cost that is attributable to the product, i.e. the cost which is traceable to the product and is a part of inventory values. On the contrary, Period Cost is just opposite to product cost, as they are not related to production, they cannot be apportioned to the product, as it is charged to the period in which they arise. Product costs are sometimes broken out into the variable and fixed subcategories. This additional information is needed when calculating the break even sales level of a business. It is also useful for determining the minimum price at which a product can be sold while still generating a profit. 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.

• Any of these types of companies may just use the term overhead rather than specifying it as manufacturing overhead, service overhead, or construction overhead.
• Period costs are hard to pinpoint to the business’s main products, but they are incurred nonetheless because they’re essential.
• Because of the different nature of product and period costs, they receive different accounting treatments.
• In other words, they are expensed in the period incurred and appear on the income statement.
• In a manufacturing organization, an important distinction exists between product costs and period costs.
• Direct costs like materials and direct labor can be easily traced to individual units of output.

Example of Period Costs

Only when they are used to produce and sell goods are they moved to cost of goods sold, which is located on the income statement. When the raw materials are brought in they will sit on the balance sheet. When the product is manufactured and then sold a corresponding amount from the inventory account will be moved to the income statement. So if you sell a widget for $20 that had $10 worth of raw materials, you would record the sale as a credit (increasing) to sales and a debit (increasing) either cash or accounts receivable. The  $10 direct materials would be a debit to cost of goods sold (increasing) and a credit to inventory (decreasing). The $10 direct materials would be a debit to cost of goods sold (increasing) and a credit to inventory (decreasing).

• Knowing the key differences between these types of costs can have a big impact on financial reporting and decision making.
• Remember, when expenses incurred may not be when cash changes hands.
• Product costs also include Depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance.
• Moreover, this understanding empowers businesses to manage costs effectively, making informed decisions about product pricing, production efficiency, and overall operational strategies.
• However, other labor, such as secretarial or janitorial staff, would instead be period 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. Product costs include the costs to manufacture products or to purchase products. If a product is unsold, the product costs will be reported as inventory on the balance sheet. When the product is sold, its cost is removed from inventory and will be included on the income statement as the cost of goods sold. Understanding the key differences between period costs and product costs is critical for strategic management accounting and decision making.

Considerations in Production Costs Calculations

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. The product costs are sometime named as inventoriable costs because they are initially assigned to inventory and expensed only when the inventory is sold and revenue flows into the business. Examples of product costs are direct materials, direct labor, and allocated factory overhead. Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities.

Our Services

A manufacturer’s product costs are the direct materials, direct labor, and manufacturing overhead used in making its products. As shown in the income statement above, salaries and benefits, rent and overhead, depreciation and amortization, and interest are all period costs that are expensed in the period incurred. On the other hand, costs of goods sold related to product costs are expensed on the income statement when the inventory is sold. Period costs and product costs are important concepts in managerial accounting that help businesses track their expenses. Knowing the key differences between these types of costs can have a big impact on financial reporting and decision making. In summary, period costs like rent and advertising are expensed immediately each accounting period on the income statement.

Table of Contents

Balancing product and period costs is important for your business performance efficiency. Product costs help you fine-tune the price of each item you sell, ensuring profitability. Period costs guide decisions about how to efficiently rule your small business realm to stay afloat, impacting staffing, advertising, and day-to-day operations. Now that we have taken a bird’s eye view of the matching principal, let’s look into the meanings of and difference between product costs and period costs.

Examples include selling, general and administrative (SG&A) expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office. The costs are not related to the production of inventory and are therefore expensed in the period incurred. In short, all costs that are not involved in the production of a product (product costs) are period costs.

Product costs like materials are included in inventory valuation through cost of goods sold when production occurs. In a manufacturing company, overhead is generally called manufacturing overhead. (You may also see other names for manufacturing overhead, such as factory overhead, factory indirect costs, or factory burden). Service companies use service overhead, and construction companies product cost vs period cost use construction overhead. Any of these types of companies may just use the term overhead rather than specifying it as manufacturing overhead, service overhead, or construction overhead. Overhead is part of making the good or providing the service, whereas selling costs result from sales activity, and administrative costs result from running the business.