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Period Costs Definition, Example, vs Product Costs

This can be particularly important for small business owners, who have less room for error. If product and period costs are overstated or understated, or not recorded at all, your financial statements will be wrong as well. The type of labor involved will determine whether it is accounted for as a period cost or a product cost.

This ensures a joined-up workflow to help you track all costs of production while taking payments for goods and services at the same time. Product costs are those related directly to the cost of production, including things like direct labor, materials, and factory overhead. For example, a retailer would include the cost of any purchases from suppliers as well as the cost of shipping these items to a retail unit. Some materials (such as glue and thread used in manufacturing furniture) may become part of the finished product, but tracing those materials to a particular product would require more effort than is sensible.

  • For example, iron ore is a direct material to a steel company because the iron ore is clearly traceable to the finished product, steel.
  • Both of these types of expenses are considered period costs because they are related to the services consumed over the period in question.
  • If you manufacture a product, these costs would include direct materials and labor along with manufacturing overhead.
  • 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.

A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses. To quickly identify if a cost is a period cost or product cost, ask the question, “Is the cost directly or indirectly related to the production of products? Product and period costs are incurred in the production and selling of a product.

Accounting treatment

While the production process is the core activity for a manufacturing entity, there are several other activities that it must conduct to keep its operations running. These can include administrative, logistical, financial, distribution, sales and marketing functions etc. Costs incurred on these other business activities that are not specifically linked to the manufacturing process qualify as period costs. These costs include direct materials, direct labor, and factory overhead. Product and period costs are the two major classifications of costs that have different accounting treatments.

  • Such materials, called indirect materials or supplies, are included in manufacturing overhead.
  • Also, interest expense on a company’s debt would be classified as a period cost.
  • This period cost is not assigned to the products and is recorded on the income statement for the period they incurred.
  • So if you pay for two years of liability insurance, it wouldn’t be good to claim all of that expense in the period the bill was paid.

To understand the concept of traceability further, see our comparison of direct vs indirect costs, which discusses the nature of the costs and provides some examples. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Difference Between Product Cost and Period Cost

SG&A (selling, general, and administrative expenses) includes expenses for the corporate office, marketing, sales, and general business administration. Administrative expenses are non-manufacturing costs that include the costs of top administrative functions and various staff departments such as accounting, data processing, and personnel. Executive salaries, clerical salaries, office expenses, office rent, donations, research and development costs, and legal costs are administrative costs. Finally, managing product and period costs will help you establish more accurate pricing levels for your products.

Part of inventory costs

Both of these types of expenses are considered period costs because they are related to the services consumed over the period in question. 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. Product cost comprises of direct materials, direct labour and direct overheads. Period costs are based on time and mainly includes selling and administration costs like salary, rent etc. These two type of costs are significant in cost accounting, that most people don’t understand easily.

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. Because of the different nature of product and period costs, they receive different accounting treatments. Product costs form part of inventory and the balance sheet, making them inventoriable cost.

These items are directly traceable or assignable to the product being manufactured. Product costs only become an expense when they are sold and become period costss. 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.

Accurate pricing for your products

Period costs are on the income statement as expenses in the period they were incurred. Period costs describe a business’s additional costs incurred during a specific reporting period. While they still form part of the overall cost of running a business, they aren’t directly related to manufacturing a specific good or service. Direct material costs are the costs of raw materials or parts that go directly into producing products. For example, if Company A is a toy manufacturer, an example of a direct material cost would be the plastic used to make the toys. It is better to relate period costs to presently incurred expenditures that relate to SG&A activities.

The difference between product costs and period costs

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 our current tax v the flat tax v the fair tax is for forecasting or reporting affects the appropriate methodology as well. Product costs are treated as inventory (an asset) on the balance sheet and do not appear on the income statement as costs of goods sold until the product is sold.

He completed a Bachelor of Science degree in Accountancy at Silliman University in Dumaguete City, Philippines. Before joining FSB, Eric has worked as a freelance content writer with various digital marketing agencies in Australia, the United States, and the Philippines. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.

Product costs are related to the cost of purchasing inventory for sale or performing a service. Meanwhile, period costs are costs that are not related to production but are essential to the business as a whole. It’s important to distinguish between product vs period costs because the former must be deducted when a good or service is sold, whereas the latter is deducted in the period it is incurred. The difference between period costs vs product costs lies in traceability and allocability to the business’ main products and services. Easily traceable costs are product costs, but some product costs require allocation since they can’t be traced. Otherwise, costs that can’t be traced or allocated to products and services are classified as period costs or costs that are attributed to the period in which they were incurred.

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