What is the difference between product costs and period costs?

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.

• While direct costs are conveniently traceable per unit, indirect costs require effort to appropriately allocate across departments, processes, and products.
• On the other hand, costs of goods sold related to product costs are expensed on the income statement when the inventory is sold.
• Direct labor costs include the labor costs of all employees actually working on materials to convert them into finished goods.
• Because period costs immediately impact net income, managing them helps businesses increase profitability.
• Often, managers focus on the bottleneck operation, which means that their main focus is on including the direct material cost and time the product spends in the bottleneck operation.

Difference Between Product Cost and Period Cost

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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. period costs vs product costs The administration of the business entity is working throughout the year. The marketing, promotion, and sales budget is also allocated for a specific period.

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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.

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• Tracking product costs accurately impacts inventory valuation and COGS.
• This treatment of capitalizing the costs first and then charging as an expense is in line with the matching principle of accounting.
• In turn, steel becomes a direct material to an automobile manufacturer.
• Period cost refers to the passage of time incurred by the businesses even if there is no production of goods or inventory purchase.
• A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses.

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 short, any costs incurred in the process of acquiring or manufacturing a product are considered product costs. On the other hand, process costing uses an approach in which all the costs of material, labor, supplies and overhead during the batch production process are summed up. Period costs include selling and distribution expenses, and general and administrative expenses. These costs are presented directly as deductions against revenues in the income statement.

As 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. On the other hand, costs of goods sold related to product costs are expensed on the income statement when the inventory is sold. 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.

Product costs (also known as inventoriable costs) are costs assigned to products. Discover the top 5 best practices for successful accounting talent offshoring. We’re a headhunter agency that connects US businesses with elite LATAM professionals who integrate seamlessly as remote team members — aligned to US time zones, cutting overhead by 70%. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.