These costs include the costs of direct materials, direct labor, and manufacturing overhead. They will not be expensed until the finished good are sold and appear on the income statement as cost of goods sold. Period costs are closely related to periods of time rather than units of products. For this reason, businesses expense period costs in the period in which they are incurred. Accountants treat all selling and administrative expenses as period costs for external financial reporting. Examples of period costs include administrative expenses like office supplies, utilities, depreciation, and rent.

Both of these costs are considered period costs because selling and administrative expenses are used up over the same period in which they originate. These costs are identified as being either direct materials, direct labor, or factory overheads, and they are traceable or assignable to products. Indirect labor consists of the cost of labor that cannot, or will not for practical reasons, be traced to the products being manufactured. Direct labor costs include the labor costs of all employees actually working on materials to convert them into finished goods.

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 are hard to pinpoint to the business’s main products, but they are incurred nonetheless because they’re essential. Examples of period costs include rent and utilities of admin offices, finance charges, marketing and advertising, commissions, and bookkeeping fees. Speaking of financial statements, it’s important that you take the time to review your financial statements on a regular basis. As an owner, you rely on their accuracy to make key management decisions.

• Managing your costs is doubly important if you own a manufacturing business, since you’ll need to manage both product and period costs.
• Period costs, on the other hand, impact the operating expenses section.
• Administrative costs may include expenditures for a company’s accounting department, human resources department, and the president’s office.
• While the production process is the core activity for a manufacturing entity, there are several other activities that it must conduct to keep its operations running.

Access and download collection of free Templates to help power your productivity and performance. It means that DM and DL increase as production increases, and they decrease if production decreases as well. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. You’ll also be able to spot trouble spots or overspending in administrative areas or if overhead has ballooned in recent months.

What is included?

Administrative activities are the most pure form of period costs, since they must be incurred on an ongoing basis, irrespective of the sales level of a business. Selling costs can vary somewhat with product sales levels, especially if sales commissions are a large part of this expenditure. For proper financial reporting and to successfully determine revenue, pricing strategies, and cost control methods, it is necessary to distinguish between product costs and period costs. Salaries of administrative employees are considered fixed and period costs as well. Since admin employees aren’t directly involved in production, their salaries are period costs.

Being traceable means that you won’t have a hard time determining the physical quantity and its cost equivalent. Though it may be tempting to just lump your expenses together, there are three great reasons why you need to separate product and period costs for your business. Period cost is not in manufacturing or transporting the assets to their month end close process final destination. Period costs are on the income statement as expenses in the period they were incurred. Period costs describe a business’s additional costs incurred during a specific reporting period. While they still form part of the overall cost of running a business, they aren’t directly related to manufacturing a specific good or service.

Product costs are sometimes broken out into the variable and fixed subcategories. This additional information is needed when calculating the break even sales level of a business. It is also useful for determining the minimum price at which a product can be sold while still generating a profit.

Comparing Product Costs and Period Costs

All the periodic costs of a business entity are recorded in the income statement under the head of operational costs. The gross profit is calculated by subtracting the product costs from total revenues generated in a financial period. 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. Thus, it is fair to say that product costs are the inventoriable manufacturing costs, and period costs are the nonmanufacturing costs that should be expensed within the period incurred.

Part of inventory costs

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. Under one school of thought, period costs are any costs that are not product costs.

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. All types of costs are used to prepare the income statement, cash flow, and balance sheet. However, the handling of all costs in each financial statement is different. In this article, we will differentiate between the product costs and period costs for any business entity.

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

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. On the other hand Period, the cost is not a part of the manufacturing process, and that is why the cost cannot be assigned to the products. According to the Matching Principle, all expenses are matched with the revenue of a particular period. So, if the revenues are recognised for an accounting period, then the expenses are also taken into consideration irrespective of the actual movement of cash. By virtue of this concept, period costs are also recorded and reported as actual expenses for the financial year.

Indirect materials are materials used in the manufacture of a product that cannot, or will not for practical reasons, be traced directly to the product being manufactured. It is a financial exercise and a strategic need to divide costs into various categories, such as product costs vs. period costs. By studying these cost factors, businesses can make educated decisions, improve processes, and increase profits.

Head-to-Head Comparison Between Period Cost vs Product Cost (Infographics)

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.

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But, such a definition can be misconstrued given that some expenditures (like the cost of acquiring land and buildings) will be of benefit for many years. There is little difference between a retailer and a manufacturer in this regard, except that the manufacturer is acquiring its inventory via a series of expenditures (for material, labor, etc.). What is important to note about these product costs is that they attach to inventory and are thus said to be inventoriable costs.

Managing your costs is doubly important if you own a manufacturing business, since you’ll need to manage both product and period costs. Product costs, also known as direct costs or inventoriable costs, are directly related to production output and are used to calculate the cost of goods sold. Company management needs to know the total costs to price goods high enough to cover these costs and still make a normal profit. Inventoriable product costs, sometimes just product costs, are only incurred during the value chain’s production stage. Inventoriable product costs are required for the cost of the assets, that is inventory, rather than total product costs. Product costs are those related directly to the cost of production, including things like direct labor, materials, and factory overhead.

However, you’ll still have to pay the rent on the building, pay your insurance and property taxes, and pay salespeople that sell the products currently in inventory. Product costs are one of the most important costs managers need to know. Knowing the cost of a product is necessary to ensure its price is correct, or the company should increase or decrease production or even discontinue the product altogether. TranZact is a team of IIT & IIM graduates who have developed a GST compliant, cloud-based, inventory management software for SME manufacturers. It digitizes your entire business operations, right from customer inquiry to dispatch.