The difference between product costs and period costs

However, other labor, such as secretarial or janitorial staff, would instead be period costs. For a retailer, the product costs would include the supplies purchased from a supplier and any other costs involved in bringing their goods to market. In short, any costs incurred in the process of acquiring product cost vs period cost or manufacturing a product are considered product costs. Period costs include selling and distribution expenses, and general and administrative expenses. These costs are presented directly as deductions against revenues in the income statement. These costs are included as part of inventory and are charged against revenues as cost of sales only when the products are sold.

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Product costs only become an expense when they are sold and become period costss. They are all the expenses/costs listed in a firm’s income statement. Product costs (direct materials, direct labor and overhead) are not expensed until the item is sold when the product costs are recorded as cost of goods sold. Period costs are selling and administrative expenses, not related to creating a product, that are shown in the income statement in the period in which they are incurred.

What are Period Costs?

All manufacturing expenses, costs incurred in the factory or production process, (i.e., direct materials, direct labor, and factory overhead) are product costs. Direct materials, direct labor, and factory overhead are combined to form the products to be sold, hence the term “product costs”. Product costs are any costs incurred in the manufacture of a product. These costs include direct materials, direct labor, and factory overhead. If the related products are sold at once, then these costs are charged to the cost of goods sold immediately.

Not Allocable to Products & Services

Instead, they are capitalized as assets on the balance sheet as part of inventory. Only when inventory is sold are these costs transferred to the income statement as COGS. Under different costing system, product cost is also different, as in absorption costing both fixed cost and variable cost are considered as Product Cost.

• Only when the finished chair is sold does the product cost hit the income statement through cost of goods sold.
• Product costs are often treated as inventory and are referred to as “inventoriable costs” because these costs are used to value the inventory.
• These terms play a part in determining the cost of goods sold (COGS) and overall profitability.
• It’s like finding the right balance to make good products and keep the entire business in good shape.
• Selling costs can vary somewhat with product sales levels, especially if sales commissions are a large part of this expenditure.
• So, product costs become your pricing compass, guiding you to set prices that keep your bakery in business.

Key Differences Between Product Cost and Period Cost

These costs are identified as being either direct materials, direct labor, or factory overheads, and they are traceable or assignable to products. Accurate measurement of product and period costs helps you report the correct amount of expense in the income statement and assets in the balance sheet. Failing to distinguish between product vs period costs could result in an overstatement or understatement of assets and net income. The type of labor involved will determine whether it is accounted for as a period cost or a product cost. Direct labor that is tied to production can be considered a product cost.

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. They are the costs that are directly and indirectly related to producing an item. In managerial and cost accounting, period costs refer to costs that are not tied to or related to the production of inventory.

• 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.
• For example, the wood and fabric that goes into a chair, or the wages of the worker assembling it.
• 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.
• Period costs include any costs not related to the manufacture or acquisition of your product.

To make a profit and keep your bakery thriving, you’ll likely set a price for your cakes that’s higher than $10. Product costs help you set these prices, ensuring you cover all the expenses and have some left for profit. So, product costs become your pricing compass, guiding you to set prices that keep your bakery in business. So, as they don’t influence inventory valuation, period costs don’t create confusion about the value of unsold goods. Product costs are the expenses directly tied to the creation of goods or services within a business. These costs represent the financial resources invested in the production process.

Overhead cannot be directly linked to individual units and is allocated based on an appropriate cost driver. Operating expenses are the funds a business pays regularly to stay in business – rent, salaries, and advertising costs, to name a few. They play a significant role in shaping the overall profitability of a business because they directly impact how much money it gets to keep after covering all these ongoing expenses. Period costs are the expenses in a business that aren’t directly linked to making specific products or services. Instead, they’re more about keeping the business running smoothly and supporting its overall operation. Based on the association with the product, cost can be classified as product cost and period cost.

This approach aligns with the principle of matching expenses with revenue, providing a more accurate representation of the true cost of goods sold. Product costs (also known as inventoriable costs) are those costs that are incurred to acquire, manufacture or construct a product. In manufacturing companies, theses costs usually consist of direct materials, direct labor, and manufacturing overhead cost. Since they can’t be traced to products and services, we attribute them to the period in which they were incurred. Most period costs are fixed because they don’t vary from one period to another.