Product Cost vs Period Cost Top 6 Best Difference Infographics

This classification relates to the matching principle of financial accounting. Therefore, before talking about how a product cost differs from a period cost, we need to look at what the matching depreciation of assets principle says about the recognition of costs. The key difference between product cost and period cost is that product concurs when a company produces any products. Consequently, they are not apportioned to any product but charged as an expense in the income statement.

Period costs:

Eric Gerard Ruiz, a licensed CPA in the Philippines, specializes in financial accounting and reporting (IFRS), managerial accounting, and cost accounting. He has tested and review accounting software like QuickBooks and Xero, along with other small business tools. Eric also creates free accounting resources, including manuals, spreadsheet trackers, and templates, to support small business owners. Period costs are costs that cannot be capitalized on a company’s balance sheet.

• Product costs are the expenses directly tied to the creation of goods or services within a business.
• To illustrate, assume a company pays its sales manager a fixed salary.
• They only affect the income statement when inventory is sold, and the cost of inventory becomes COGS.
• Period costs are not part of manufacturing overhead and do not directly relate to making the product.
• By understanding the differences between product and period costs, businesses can more accurately manage their expenses and assess profitability.

Indirect labor consists of the cost of labor that cannot, or will not for practical reasons, be traced to the products being manufactured. 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.

Product Costs

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. 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. The product costs are sometime named as inventoriable costs because they are initially assigned to inventory and expensed only when the inventory is sold and revenue flows into the business. 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.

Introduction to Period Costs

If the related products are sold at once, then these costs are charged to the cost of goods sold immediately. If the products are not sold right away, then these costs are instead capitalized into the cost of inventory, and will be charged to expense later, when the products are eventually sold. Understanding the distinction between product costs and period costs is fundamental in cost accounting, as it helps businesses accurately track expenses and evaluate financial performance. These two cost categories are critical for allocating expenses between production-related activities and general business operations. In managerial and cost accounting, period costs refer to costs that are not tied to or related to the production of inventory. Examples include selling, general and administrative (SG&A) expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office.

So, take a read of the article, that sheds light on the differences between product cost and period cost. If how to close a business 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.

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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. Administrative expenses are non-manufacturing costs that include the costs of top administrative functions and various staff departments such as accounting, data processing, and personnel. Executive salaries, clerical salaries, office expenses, office rent, donations, research and development costs, and legal costs are administrative costs. By understanding the differences between product and period costs, businesses can more accurately manage their expenses and assess profitability. 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.

What are Operating Expenses?

We need to first revisit the concept of the matching principle from financial accounting. Period costs are always recognized in profit or loss in the period in which they are incurred. In summary, product costs are recognized in the balance sheet before being expensed in the income statement.

The timing of period costs

These costs are not part of the manufacturing process and are, therefore, treated as expense for the period in which they arise. Period costs are not attached to products and the company does not need to wait for the sale of its products to recognize them as expense on income statement. According to generally accepted accounting principles (GAAPs), all selling and administrative costs are treated as period costs. This means that these costs directly impact the income statement for the specific time frame.

Practical Considerations for Businesses

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Product Costs vs Period Costs: A Guide to Costs of Product

• Eric also creates free accounting resources, including manuals, spreadsheet trackers, and templates, to support small business owners.
• If they do increase, these increases happen only once or twice a year.
• Direct labor costs include the labor costs of all employees actually working on materials to convert them into finished goods.
• In summation, appreciating the difference between product and period cost is essential for accurate financial reporting.
• Such a treatment of period costs is in accordance with the accrual concept of financial accounting.
• These are more like ongoing business expenses, not tied to a particular product but necessary for keeping the lights on.

These can include administrative, logistical, financial, distribution, sales and marketing functions etc. Costs incurred on these other business activities that are not specifically linked to the manufacturing process qualify as period costs. Selling expenses are costs incurred to obtain customer orders and get the finished product in the customers’ possession. Advertising, market research, sales salaries and commissions, and delivery and storage of finished goods are selling costs. The costs of delivery and storage of finished goods are selling costs because they are incurred after production has been completed. Therefore, the costs of storing materials are part of manufacturing overhead, whereas the costs of storing finished goods are a part of selling costs.

This may require robust internal controls and accounting software to track and record transactions accurately. Businesses should also seek professional financial advice or use specialized consulting services to navigate complex categorizations. A meticulous approach to accounting ensures compliance and enhances the seven step revenue cycle of a healthcare practice overall financial oversight. In addition to categorizing costs as manufacturing and nonmanufacturing, they can also be categorized as either product costs or period costs.

For example, iron ore is a direct material to a steel company because the iron ore is clearly traceable to the finished product, steel. In turn, steel becomes a direct material to an automobile manufacturer. Period costs are like the backstage crew ensuring the business show runs smoothly. Remenber, they include things like rent, salaries, and advertising costs? But they’re ongoing expenses necessary for the daily operation of the entire bakery.