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Period Costs vs Product Costs: What’s the Difference?
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- When inventory is purchased, it constitutes an asset on the balance sheet (i.e., “inventory”).
- Therefore, the cost of inventories (Cost of Goods Sold, or COGS) is the same as product costs.
- If you manufacture a product, these costs would include direct materials and labor along with manufacturing overhead.
- That would depend on whether the depreciation is on property and equipment related to the manufacturing process or not.
- He has a CPA license in the Philippines and a BS in Accountancy graduate at Silliman University.
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. The difference between period costs vs product costs lies in traceability and allocability to the business’ main products and services. Easily traceable costs are product costs, but some product costs require allocation since they can’t be traced. Otherwise, costs that can’t be traced or allocated to products and services are classified as period costs or costs that are attributed to the period in which they were incurred. Period costs include any costs not related to the manufacture or acquisition of your product.
Period Costs (Definition And Examples: All You Need To Know)
It is important to understand through the accrual method of accounting, that expenses and income should be recognized when incurred, not necessarily when they are paid or cash received. 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. Only when they are used to produce and sell goods are they moved to cost of goods sold, which is located on the income statement. 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.
Period Cost vs Product Cost
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. Items that are not period costs are those costs included in prepaid expenses, such as prepaid rent. Also, costs included in inventory, such as direct labor, direct materials, and manufacturing overhead, are not classified as period costs. Finally, costs included in fixed assets, such as purchased assets and capitalized interest, are not considered to be period costs.
In the case of manufacturers, it is any cost incurred to produce the products to be able to sell them. Period costs are costs that cannot be capitalized on a company’s balance sheet. In other words, they are expensed in the period incurred and appear on the income statement. When costs are traceable to products and services, they are undeniably product costs. Being traceable means that you won’t have a hard time determining the physical quantity and its cost equivalent. Below is a simple flowchart we designed that summarizes how to distinguish period costs vs product costs.
Product Versus Period Costs
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. If the cost isn’t traceable and allocable to products and services, this cost is a period cost. Period costs are essential to business operations but don’t directly affect the final products. To continue our bakery example, let’s say we’re hiring an external bookkeeper to do the books. By analogy, a manufacturer pours money into direct materials, direct labor, and manufacturing overhead.
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. Another way to identify period costs is to establish what doesn’t qualify as such.
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. On the other hand, a company that does not produce goods or does not carry inventory of any kind will not have any product costs to report on its financial statements. Costs and expenses that are capitalized, related to fixed assets, related to purchase of goods, or any other capitalized interest are not period 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. In other words, manufacturers incur product costs to produce inventories. Therefore, the cost of inventories (Cost of Goods Sold, or COGS) is the same as product costs. Since inventories are recorded as assets for the manufacturers, product costs are recorded on the balance sheet in the assets section under inventories. In other words, product costs are expenses that are initially “parked” in the balance sheet and recorded only as an expense (COGS) upon sale.
How are product costs reported in financial statements?
However, these costs are still paid every period, and so are booked as period costs. To quickly identify if a cost is a period cost or product cost, ask the question, “Is the cost directly or indirectly related to the production of products? A soft drink manufacturer might spend very little on producing the product, but a lot on selling. Conversely, a steel mill may have high inventory costs, but low selling expenses. It is better to relate period costs to presently incurred expenditures that relate to SG&A activities. These costs do not logically attach to inventory and should be expensed in the period incurred.
