In summary, proper classification of costs as either product or period expenses is vital for financial reporting accuracy and strategic business management. Companies that develop strong costing systems and discipline around classifications put themselves in a superior competitive position. In a manufacturing organization, an important distinction exists between product costs and period costs. Examples of period costs include selling costs and administrative costs. In a manufacturing organization, an important difference exists between product costs and period costs.

Components of Product Costs: Direct Materials, Labor, and Overhead

Tracking period costs will also help a business balance its budget and gain savings. It will also allow a business to focus on growing and controlling direct costs. Because product and period costs directly impact your financial statements, you need to properly categorize and record these costs in order to ensure accurate financial statements.

• Management can plan by diversifying decision-making teams, skill development, using technology effectively, and engaging in ongoing communication with suppliers and other stakeholders.
• Office rent, advertising expenses and business insurance all fall into this category.
• If the related products are sold at once, then these costs are charged to the cost of goods sold immediately.
• Production costs are usually part of the variable costs of business because the amount spent will vary in proportion to the amount produced.
• Both product costs and period costs may be either fixed or variable in nature.

Depreciation

Every cost incurred by a business can be classified as either a period cost or a product cost. A product cost is incurred during the manufacture of a product, while a period cost is usually incurred over a period of time, irrespective of any manufacturing activity. A product cost is initially recorded as inventory, which is stated on the balance sheet. Once the inventory is sold or otherwise disposed of, it is charged to the cost of goods sold on the income statement. A period cost is charged to expense on the income statement as soon as it is incurred.

Top 5 Practice Management Software: An In-depth Review

Legal fees, sales commissions and office supplies are considered period costs and should be recorded as expenses on the balance sheet. To summarize, product costs are inventoried and then recognized as expense upon sale of the product. Period costs relate to operating the business during total period cost an accounting period and are directly expensed on the income statement. Understanding how costs flow through the financial statements is an essential concept in managerial accounting and cost analysis. Both period and product costs are tied to a company’s performance and growth strategy.

If the manufactured products are not all sold, the income statement would not show the full expenses incurred during the period. In addition, absorption costing takes into account all costs of production, such as fixed costs of operation, factory rent, and cost of utilities in the factory. It includes direct costs such as direct materials or direct labor and indirect costs such as plant manager’s salary or property taxes. It can be useful in determining an appropriate selling price for products.

Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities. 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. 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.

If product and period costs are overstated or understated, or not recorded at all, your financial statements will be wrong as well. Period costs are not assigned to one particular product or the cost of inventory like product costs. Therefore, period costs are listed as an expense in the accounting period in which they occurred.

As a general rule, costs are recognized as expenses on the income statement in the period that the benefit was derived from the cost. 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. Since the expense covers a two year period, it should be recognized over both years. Period costs take up most of the space on the expense section of your income statement. That would depend on whether the depreciation is on property and equipment related to the manufacturing process or not. Even though this cost is directly related to products, it has nothing to do with producing them.

• Unlike period costs, product costs are tied to the production of a product.
• The best way to calculate total period costs is to use your income statement as a checklist.
• It includes direct costs such as direct materials or direct labor and indirect costs such as plant manager’s salary or property taxes.
• As a non-cash expense, depreciation appears on the income statement but does not directly drain cash flow.
• Alternatively, the costs of wood, fabric, nails and other materials that physically go into building a chair are product costs.
• If you pay rent for your office and manufacture your products in a separate facility, office rent is a period cost.

Period costs can be separated by category on the income statement to help understand what the costs are and how much is spent on each. This way you’ll have a better idea of the expenses and give a better idea of the net income of your company. Recording product and period costs may also save you some money come tax time, since many of these expenses are fully deductible.