Difference Between Product Costs and Period Costs Examples

CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path. Learn about emerging trends and how staffing agencies can help you secure top accounting jobs of the future. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.

Product costs also include Depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance. In a manufacturing organization, an important distinction exists between product costs and period costs. Both of these costs are considered period costs because selling and administrative expenses are used up over the same period in which they originate.

Overhead or sales, general, and administrative (SG&A) costs are considered period costs. SG&A includes costs of the corporate office, selling, marketing, and the overall administration of company business. In financial accounting, product costs are initially carried as inventory in the books and are reflected as a current asset in the balance sheet.

Would you prefer to work with a financial professional remotely or in-person?

They only affect the income statement when inventory is sold, and the cost of inventory becomes COGS. Moreover, period costs are expenses in the income statement of the period in which they were incurred. Selling expenses are costs incurred to obtain customer orders and get the finished product in the customers’ possession.

Examples of Product Costs

• Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.
• Since they are not product costs, period costs will not be included in the cost of inventory.
• Executive salaries, clerical salaries, office expenses, office rent, donations, research and development costs, and legal costs are administrative costs.
• Grasping the difference between product and period costs serves as a financial compass for businesses.
• Understanding the key differences between period costs and product costs is critical for strategic management accounting and decision making.

For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. Careful analysis of cost behavior is key to proper accounting classification and supporting smart management of margins and profits. Proper classification of costs is thus essential for businesses to improve profitability. Today, we’re breaking down these two concepts to understand their general aspects, relationship with financial statements, and overall impact on business decision-making. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. Finance Strategists has an advertising relationship with some of the companies included on this website.

• Period costs are based on time and mainly includes selling and administration costs like salary, rent etc.
• To summarize, product costs are inventoried and then recognized as expense upon sale of the product.
• In addition to indirect materials and indirect labor, manufacturing overhead includes depreciation and maintenance on machines and factory utility costs.
• In summary, period costs like rent and advertising are expensed immediately each accounting period on the income statement.
• For example, understating product costs decreases COGS and increases net income.
• Tracking product costs accurately impacts inventory valuation and COGS.

Great! The Financial Professional Will Get Back To You Soon.

This means that these costs directly impact the income statement for the specific time frame. 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.

Is Depreciation a Period Cost? Understanding Fixed Expenses

Product cost and period cost are accounting concepts used to categorize and allocate expenses in a business. These terms play a part in determining the cost of goods sold (COGS) and overall profitability. If the cost didn’t pass the traceability test, it is an overhead cost. Allocation is the only way to account for overhead since we can’t pinpoint its direct relationship to products and services. Below is a simple flowchart we designed that summarizes how to distinguish period costs vs product costs.

Administrative expenses

In a nutshell, we can say that all the costs which are not product costs are period costs. The simple difference between the two is that Product product cost vs period cost Cost is a part of Cost of Production (COP) because it can be attributable to the products. On the other hand Period, the cost is not a part of the manufacturing process, and that is why the cost cannot be assigned to the products. In a manufacturing organization, an important difference exists between product costs and period costs. All components are added together and recorded as part of inventory. In other words, product costs are expenses that are initially “parked” in the balance sheet and recorded only as an expense (COGS) upon sale.

If the products are not sold right away, then these costs are instead capitalized into the cost of inventory, and will be charged to expense later, when the products are eventually sold. The costs that are not classified as product costs are known as period costs. These costs are not part of the manufacturing process and are, therefore, treated as expense for the period in which they arise. Period costs are not attached to products and the company does not need to wait for the sale of its products to recognize them as expense on income statement. According to generally accepted accounting principles (GAAPs), all selling and administrative costs are treated as period costs. Product cost comprises of direct materials, direct labour and direct overheads.