Period costs include selling expenses and administrative expenses that are unrelated to the production process in a manufacturing business. Selling expenses are incurred to market products and deliver them to customers. Administrative expenses are required to provide support services not directly related to manufacturing or selling activities.

However, other labor, such as secretarial or janitorial staff, would instead be period costs. Both product costs and period costs may be either fixed or variable in nature. Company management needs to know the total costs to price goods high enough to cover these costs and still make a normal profit. Inventoriable product costs, sometimes just product costs, are only incurred during the value chain’s production stage. Inventoriable product costs are required for the cost of the assets, that is inventory, rather than total product costs. Product costs are those related directly to the cost of production, including things like direct labor, materials, and factory overhead.

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Managerial Accounting

Regardless of the business size, it is essential to understand the different product, operational, and non-operational costs involved in your business to differentiate each one from the other. Many employees receive fringe benefits paid for by employers, such as payroll taxes, pension costs, and paid vacations. These fringe benefit costs can significantly increase the direct labor hourly wage rate. Other companies include fringe benefit costs in overhead if they can be traced to the product only with great difficulty and effort.

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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. A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses. When depreciation applies to assets like office equipment, it is considered a period expense. However, when it is used for manufacturing equipment, it becomes a portion of the product cost.

Why is it important to distinguish between product costs and period costs?

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The difference between product costs and period costs

All costs that are not classified as product costs can be classified as period costs. These are generally the costs not directly tied to production, so include overheads and administration costs. Unlike product costs, period costs won’t be assigned to a specific product and will typically be declared an expense during whatever accounting period they occurred within. All the period costs are recorded in the income statement and cash flow statement of the company. These costs are recorded in accounting books as incurred with the same name.

Comparing Product Costs and Period Costs

For this reason, businesses expense period costs in the period in which they are incurred. Accountants treat all selling and administrative expenses as period costs for external financial reporting. Examples of period costs include administrative expenses like office supplies, utilities, depreciation, and rent. Interest expenses, marketing, and corporate sales costs are also included in this category. These are incurred whether the business manufactures or acquires goods and are considered indirect costs of production. Rather than being listed as inventory, period costs are listed as expenses for each accounting period.

When the raw materials are brought in they will sit on the balance sheet. When the product is manufactured and then sold a corresponding amount from the inventory account will be moved to the income statement. So if you sell a widget for $20 that had $10 worth of raw materials, you would record the sale as a credit (increasing) to sales and a debit (increasing) either cash or accounts receivable. The  $10 direct materials would be a debit to cost of goods sold (increasing) and a credit to inventory (decreasing).

Product costs are always considered variable costs, as they rise and fall according to production levels. They are the costs that are directly and indirectly related to producing an item. As the difference between petty cash and cash on hand shown in the income statement above, salaries and benefits, rent and overhead, depreciation and amortization, and interest are all period costs that are expensed in the period incurred.

Finally, managing product and period costs will help you establish more accurate pricing levels for your products. From the above description, we can conclude that the cost due to the manufacturing unit is product cost, and the cost other than product cost is a period cost. Period cost is not in a straight line with the production of the end product. This period cost is not assigned to the products and is recorded on the income statement for the period they incurred.

Most period costs are considered periodic fixed expenses, although in some instances, they can be semi-variable expenses. For example, you receive a utility bill each month that is not directly tied to production levels, but the amount can vary from month to month, making it a semi-variable expense. On the other hand, period costs are considered indirect costs or overhead costs, and while they play an important role in your business, they are not directly tied to production levels. This could be anything from the cost of the raw materials and labour costs to manufacturing supplies and the overheads tied to production like energy usage.

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 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.

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