What is the Difference Between Product Costs And Period Costs?

Product costs only become an expense when they are sold and become period costss. All manufacturing expenses, costs incurred in the factory or production process, (i.e., direct materials, direct labor, and factory overhead) are product costs. Direct materials, direct labor, and factory overhead are combined to form the products to be sold, hence the term «product costs». Product costs (direct materials, direct labor and overhead) are not expensed until the item is sold when the product costs are recorded as cost of goods sold.

Module 1: Nature of Managerial Accounting

Proper classification and monitoring of period versus product costs are vital for accurate financial reporting. While period costs directly hit the income statement, product costs impact inventory valuation and flow through to COGS. Understanding these differences helps businesses make sound accounting decisions. The costs that are not classified as product costs are known as 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.

• In a manufacturing organization, an important difference exists between product costs and period costs.
• Period costs are always recognized in profit or loss in the period in which they are incurred.
• Examples of period costs include selling costs and administrative costs.
• Product costs are recorded as inventory in the financial statements until the product has been sold.
• Overhead or sales, general, and administrative (SG&A) costs are considered period costs.

Examples

Management can identify cost overrun areas by periodically analyzing both product costs and period costs. This can eventually help the entity take corrective action to lower costs and improve profitability. The administration of the business entity is working throughout the year. The marketing, promotion, and sales budget is also allocated for a specific period.

• The $10 direct materials would be a debit to cost of goods sold (increasing) and a credit to inventory (decreasing).
• Costs incurred on these other business activities that are not specifically linked to the manufacturing process qualify as period costs.
• Period costs can be defined as any cost or expense items listed in the firm’s income statement.
• For example, a manufacturer may pay $5,000 per month in rent for its factory.
• Product costs are sometimes broken out into the variable and fixed subcategories.
• Below is a break down of subject weightings in the FMVA® financial analyst program.
• Therefore, period costs are only recognized as expenses in the income statement.

For example, the wood and fabric that goes into a chair, or the wages of the worker assembling it. 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 period costs vs product costs are costs that cannot be capitalized on a company’s balance sheet.

As the name suggests, product costs are derived from producing major types of products by the business. Product cost is only incurred when some product is acquired or produced. If there is no production of any goods, the business will incur no product cost. Under different costing system, product cost is also different, as in absorption costing both fixed cost and variable cost are considered as Product Cost. On the other hand, in Marginal Costing only the variable cost is regarded as product cost.

Period Costs vs. Product Costs: What’s the Difference?

In this post, you’ll learn the key differences between period and product costs along with real-world examples to clearly illustrate the implications of proper classification. To illustrate, assume a company pays its sales manager a fixed salary. If a manufacturer leases its manufacturing plant and equipment, the lease is a product cost (as opposed to a period cost). That is, rent is included in the manufacturing overhead assigned to the goods produced. In a nutshell, we can say that all the costs which are not product costs are period costs. The simple difference between the two is that Product Cost is a part of Cost of Production (COP) because it can be attributable to the products.

Comparing Product Costs and Period Costs

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Financial Planning and Analysis (FP&A)

Period costs are selling and administrative expenses, not related to creating a product, that are shown in the income statement in the period in which they are incurred. In general, overhead refers to all costs of making the product or providing the service except those classified as direct materials or direct labor. Manufacturing overhead costs are manufacturing costs that must be incurred but that cannot or will not be traced directly to specific units produced. In addition to indirect materials and indirect labor, manufacturing overhead includes depreciation and maintenance on machines and factory utility costs.

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For a bakery, the costs of ingredients and baking supplies that go into making their baked goods are considered product costs. Their general shop lease, utilities, and owner’s salary are period costs. Product costs (also known as inventoriable costs) are those costs that are incurred to acquire, manufacture or construct a product. In manufacturing companies, theses costs usually consist of direct materials, direct labor, and manufacturing overhead cost. Examples of product costs include the cost of raw materials used, depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance. The difference between period costs vs product costs lies in traceability and allocability to the business’ main products and services.

We still include MOH as part of product costs even if we can’t trace them directly. Product and period costs are the two major classifications of costs that have different accounting treatments. Product costs are related to the cost of purchasing inventory for sale or performing a service. Meanwhile, period costs are costs that are not related to production but are essential to the business as a whole. It’s important to distinguish between product vs period costs because the former must be deducted when a good or service is sold, whereas the latter is deducted in the period it is incurred.