Period Cost vs Product Cost Period Cost Examples & Formula Video & Lesson Transcript

The most common of these costs are direct materials, direct labor, and manufacturing overhead. Inventoriable costs are all costs of a product that are considered assets when the costs are incurred and are expensed as cost of goods sold once the product is sold. These costs are different from period costs because these costs are initially capitalized to inventory. They are capitalized to inventory because when a product is in the process of being manufactured, work in process costs are being incurred and value is added throughout the process, not all at once.

• Managers are always on the lookout for ways to reduce costs while trying to improve the overall effectiveness of their operations.
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• Direct labor that is tied to production can be considered a product cost.
• The most common product costs are direct materials, direct labor, and manufacturing overhead.

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What are ways to reduce or eliminate period expenses?

Costs are classified as period costs if they are non-manufacturing costs incurred during the period. Operating expenses are expenses related to daily operations, whereas period expenses are those costs that have been paid during the current accounting period but will benefit future periods. 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. In short, any costs incurred in the process of acquiring or manufacturing a product are considered product costs. The type of labor involved will determine whether it is accounted for as a period cost or a product cost.

Production costs are usually part of the variable costs of business because the amount spent will vary in proportion to the amount produced. However, the costs of machinery and operational spaces are likely to be fixed proportions of this, and these may well appear under a fixed cost heading or be recorded as depreciation on a separate accounting sheet. These costs should be monitored closely so managers can find ways to reduce the amount paid when possible. Period expenses are usually calculated by adding together all expected payments for a period, then subtracting any amounts that were paid early. The person creating the production cost calculation, therefore, has to decide whether these costs are already accounted for or if they must be a part of the overall calculation of production costs.

If the rented building is used as a manufacturing facility, it is a product cost. Salary can be both a product cost and a period cost depending on the activities of the worker. Salary paid for the production floor manager is classified as a product cost since the cost is incurred for actual production of the product. Salary paid to an executive is a period cost, since the executive does not work directly on product production. There are types of period costs that may not be included in the financial statements but are still monitored by the management.

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. The expenses that are compiled for the calculation of Period costs are not related Other expenses will not be considered as a period cost because they are directly related to the process of production of inventory.

Understanding Period Costs

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. 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).

What is paid during that period was $100,000 in rent and utilities, but only $10,000 in insurance and property taxes because a storm damaged the roof of one of its properties. During the fourth quarter of 2016, Company XYZ expected to pay $150,000 in rent and utilities and $100,000 in insurance and property taxes. Period expenses are costs that help a business or other entity generate revenue, but aren’t part of the cost of goods sold. Product expenses are part of the cost of producing or acquiring an asset. Examples include production materials consumed in making a product and commissions paid to salespeople. Operating expenses are costs that businesses expect to incur in their attempts to generate revenue.

Considerations in Production Costs Calculations

Direct labor that is tied to production can be considered a product cost. However, other labor, such as secretarial or janitorial staff, would instead be period costs. Overhead, or the costs to keep the lights on, so to speak, such as utility bills, insurance, and rent, are not directly related to production. However, these costs are still paid every period, and so are booked as period costs. Both product costs and period costs may be either fixed or variable in nature. Rent can be a period cost or a product cost depending on what the rented building is used for.

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. Looking at these expenses the utilities for the manufacturing facility and the production worker’s wages are both product costs because these are manufacturing overhead costs and direct labor costs. Utilities for the retail shop as well as the cashier’s wages are period costs.

On the other hand, the administrative assistant’s salary is a period cost since she works in the office and not on the production floor. Finally, both executives’ salaries are period costs since they also do not work on the production floor. 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.

How to Identify a Period Cost

There are many costs businesses incur that are not related directly to product manufacturing. The most common of these costs are sales and marketing costs and administrative costs. Sales and marketing costs may be commission for the sales team, salary for the marketing team, advertising costs to boost brand awareness, market research, and product design.

• If the rented building is used as a manufacturing facility, it is a product cost.
• The company has three executives who each get paid $250,000 every quarter.
• Overhead, or the costs to keep the lights on, so to speak, such as utility bills, insurance, and rent, are not directly related to production.
• In short, all costs that are not involved in the production of a product (product costs) are period costs.

At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. In these cases, a more feasible alternative is to try and reduce the amount paid in earlier years. What remains is the total amount of expected expenditures during the period.

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. 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 company has one very large manufacturing facility but has a few dealerships and offices around the country. The company manufactured and sold 1,000 cars during the fourth quarter. Each car costs $10,000 in direct materials, $10,000 in direct labor, and $20,000 in manufacturing overhead. The company has three executives who each get paid $250,000 every quarter. Additionally, the company employs one lawyer who gets paid $75,000 every quarter, and one accountant who gets paid $75,000 every quarter.

Also, they spent $1,000,000 on market research and $1,000,000 to boost brand awareness during the fourth quarter. This company has $3,400,000 in period costs for the fourth quarter from their selling, marketing, and administrative expenses. Their selling expense is from the commission they pay their salespeople. Their administrative costs are from executive salaries and professional costs. Product costs are all costs involved in the acquisition or manufacturing of a product. Product costs become part of cost of goods sold once the product is sold.

These costs does not constitute to production of inventory and hence these costs can never be capitalized and always form part of the income statement of the company. Examples of these costs are Selling cost, overhead costs, advertisement costs etc. Every cost incurred by a business can be classified as either a period cost or a product cost.