Period Costs Definition, Example, vs Product Costs

As the name suggests, period costs are those costs which are incurred due to the passage of time. They don’t form part of the cost of inventory and thus are expensed to the profit and loss account as and when they are incurred by the entity. Such a treatment of period costs is in accordance with the accrual concept of financial accounting.

Allocable to Products & Services

Commercial entities regularly incur different types of costs while carrying out their business activities. These costs can be broadly bifurcated into costs related to the core production/trading activities and other ancillary costs. While preparing their books of accounts, manufacturing entities in particular prepare a separate trading account and a separate profit and loss account.

But they’re ongoing expenses necessary for the daily operation of the entire bakery. A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses. These costs tend to be clustered into the selling, general and administrative classifications of expenses, and appear in the lower half of a reporting entity’s income statement. The concept of product vs period costs is a subset of cost accounting. Read our article about managerial accounting to learn more about how it can help your business manage costs.

Why is the distinction between product costs and period costs important?

Tracking product costs accurately impacts inventory valuation and COGS. For example, understating product costs decreases COGS and increases net income. Alternatively, the costs of wood, fabric, nails and other materials that physically go into building a chair are product costs. Only when the finished chair is sold does the product cost hit the income statement through cost of goods sold.

Costs incurred on these other business activities that are not specifically linked to the manufacturing process qualify as period costs. To summarize, product costs are inventoried and then recognized as expense upon sale of the product. Period costs relate to operating the business during an accounting period and are directly expensed on the income statement.

• The main benefit of classifying costs as either product or period is that it helps managers understand where their costs are being incurred and how those costs relate to the production process.
• Sales commissions, administrative costs, advertising and rent of office space are all period costs.
• If the related products are sold at once, then these costs are charged to the cost of goods sold immediately.
• Instead, they’re more about keeping the business running smoothly and supporting its overall operation.
• The product costs for a retailer will be the amount paid to the supplier plus any freight-in.

A quick look at period costs

Eric is an accounting and bookkeeping expert for Fit Small Business. He has a CPA license in the Philippines and a BS in Accountancy graduate at Silliman University. Integrate financial data from all your sales channels in your accounting to have always accurate records ready for reporting, analysis, and taxation.

People often confuse product and period costs due to the complexity of accounting terminology and the different ways these costs are treated in financial reporting. In addition to categorizing costs as manufacturing and nonmanufacturing, they can also be categorized as either product costs or period costs. This classification relates to the matching principle of financial accounting. Therefore, before talking about how a product cost differs from a period cost, we need to look at what the matching principle says about the recognition of costs. According to the Matching Principle, product cost vs period cost all expenses are matched with the revenue of a particular period. So, if the revenues are recognised for an accounting period, then the expenses are also taken into consideration irrespective of the actual movement of cash.

• Failing to distinguish between product vs period costs could result in an overstatement or understatement of assets and net income.
• Period costs are closely related to periods of time rather than units of products.
• For example, a manufacturer may pay $5,000 per month in rent for its factory.
• If a company’s management understands both product and period costs, they can use it in improving decision-making.
• Operating expenses are the funds a business pays regularly to stay in business – rent, salaries, and advertising costs, to name a few.
• The cash may actually be spent on an item that will be incurred later, like insurance.
• This treatment of capitalizing the costs first and then charging as an expense is in line with the matching principle of accounting.

Imagine your favorite bakery – the cost of flour, sugar, and the baker’s time to make those croissants you’re so fond of. The main benefit of classifying costs as either product or period is that it helps managers understand where their costs are being incurred and how those costs relate to the production process. This information can be used to make decisions about where to allocate resources and how to improve efficiency. In other words, period costs are related to the services consumed over the period in question. Direct Labor refers to the wages paid to production workers who are directly involved in making the product, such as assembly line workers, woodworkers, tailors, etc. Freight costs can be categorized as either a product cost or a period cost, depending on the context.

AccountingTools

Period cost (often referred to as period expense) is any other cost that is incurred by the entity that does not directly relate to the entity’s manufacturing process. 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.

Comparing Product Costs and Period Costs

Period costs include any costs not related to the manufacture or acquisition of your product. Sales commissions, administrative costs, advertising and rent of office space are all period costs. These costs are not included as part of the cost of either purchased or manufactured goods, but are recorded as expenses on the income statement in the period they are incurred. Remember, when expenses incurred may not be when cash changes hands. 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.

We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own. Discover the top 5 best practices for successful accounting talent offshoring. Accounting for both types of expenses is key for profitable pricing strategies. We’re a headhunter agency that connects US businesses with elite LATAM professionals who integrate seamlessly as remote team members — aligned to US time zones, cutting overhead by 70%. Product costs (also known as inventoriable costs) are costs assigned to products.

Not Allocable to Products & Services

In this post, you’ll learn the key differences between period and product costs along with real-world examples to clearly illustrate the implications of proper classification. The balance sheet is another critical financial statement product costs relate to. It’s a snapshot of a business’s financial health at a specific moment. And product costs play a significant role, especially in valuing the goods a company hasn’t sold yet. These are more like ongoing business expenses, not tied to a particular product but necessary for keeping the lights on. Period costs are sometimes broken out into additional subcategories for selling activities and administrative activities.