What is the difference between product costs and period costs?

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 product cost vs period cost used up over the same period in which they originate.

Period costs:

Direct Materials include the raw materials and components that go directly into a finished product, such as wood, fabric, electronics, etc. Most business owners would agree that properly classifying costs as either “period” or “product” expenses is critical for accurate financial reporting and strategic decision making. Period costs are like the backstage crew ensuring the business show runs smoothly. Remenber, they include things like rent, salaries, and advertising costs?

Period costs don’t impact inventory valuation

Understanding period costs helps assess the day-to-day financial health of a business. And while product costs focus on the creation of goods or services, period costs represent the broader expenses necessary to sustain the business’s overall operations and facilitate growth. Unlike product costs, period costs don’t depend on the production volume.

Administrative expenses are required to provide support services not directly related to manufacturing or selling activities. Administrative costs may include expenditures for a company’s accounting department, human resources department, and the president’s office. If you manufacture a product, these costs would include direct materials and labor along with manufacturing overhead. Most of the components of a manufactured item will be raw materials that, when received, are recorded as inventory on the balance sheet.

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. So, take a read of the article, that sheds light on the differences between product cost and period cost.

Company

Let’s discuss the accounting treatment of product costs and period costs in greater detail. Both product costs and period costs may be either fixed or variable in nature. For example, a manufacturer may pay $5,000 per month in rent for its factory. The rent expense is recorded on the income statement each month whether 1,000 units or 10,000 units are manufactured. There is no way to trace the rent cost to specific units of production.

Difference Between Product Costs and Period Costs FAQs

• In other words, they are initially classified as assets and are transferred to expense when they are sold.
• 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.
• Today, we’re breaking down these two concepts to understand their general aspects, relationship with financial statements, and overall impact on business decision-making.
• Below is a simple flowchart we designed that summarizes how to distinguish period costs vs product costs.
• 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.
• Manufacturing overhead costs are manufacturing costs that must be incurred but that cannot or will not be traced directly to specific units produced.

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.

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.

• Out of these 500 units manufactured, the company sells only 300 units during the year 2022 and 200 unsold units remain in ending inventory.
• Examples of product costs include the cost of raw materials used, depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance.
• Product costs are the expenses directly tied to the creation of goods or services within a business.
• Most period costs are fixed because they don’t vary from one period to another.
• They are incurred whether or not production occurs during the period.
• Indirect costs like supervision, utilities, and equipment repairs cannot be directly linked to specific units of production.

By virtue of this concept, period costs are also recorded and reported as actual expenses for the financial year. Examples of period costs include selling costs and administrative costs. Salaries of administrative employees are considered fixed and period costs as well.

Understanding the Total Costs Involved in Manufacturing an Item

Understanding how costs flow through the financial statements is an essential concept in managerial accounting and cost analysis. Instead, they are included in the cost basis of inventory through cost of goods sold as production occurs. The key difference is product costs can be traced to specific units produced, while period costs cannot. Grasping the difference between product and period costs serves as a financial compass for businesses. It’s like having a roadmap that guides accurate financial reporting, ensuring that the numbers on the balance sheet and income statement tell a clear and truthful story about the business’s health. Moreover, this understanding empowers businesses to manage costs effectively, making informed decisions about product pricing, production efficiency, and overall operational strategies.

Period costs affect Operating Expenses, impacting overall profitability on the Income statement.

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.

Discover the key to effective financial management with our straightforward guide on variance reporting. Period costs are of no less help, as they allow you to understand how well you’re running your business. 11 Financial is a registered investment adviser located in Lufkin, Texas. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.