Understanding these differences provides a clearer view of a company’s operational efficiency and financial health. Costs are classified into product costs and period costs on the basis of whether they are capitalized to the cost of products produced or not. In addition to categorizing costs as manufacturing and nonmanufacturing, they can also be categorized as either product costs or period costs. This classification relates to the matching principle of financial accounting.

Costs that become part of the cost of goods manufactured are called product costs. Such costs are incurred on manufacturing process either directly as material and labor costs or indirectly as overheads. This is achieved by debiting product costs to the cost of goods manufactured and thus expensed only at the time of sale of such goods. Accurate measurement of product and period costs helps you report the correct amount of expense in the income statement and assets in the balance sheet.

Example of Period Costs

An example of such cost is the cost of material, labour, and overheads employed in manufacturing a table. Administrative expenses cover general operational costs, such as executive salaries, office supplies, and utilities for non-manufacturing facilities. For example, the salary of a chief financial officer or the upkeep of corporate headquarters falls under this category. Direct labor includes wages and salaries for employees directly involved in production, such as machinery operators or assembly workers. Labor union agreements and overtime regulations, like those under the Fair Labor Standards Act (FLSA) in the United States, can impact these 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 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). The $10 direct materials would be a debit to cost of goods sold (increasing) and a credit to inventory (decreasing).

• Selling costs can vary somewhat with product sales levels, especially if sales commissions are a large part of this expenditure.
• These costs are not part of the manufacturing process and are, therefore, treated as expense for the period in which they arise.
• A manufacturer’s product costs are the direct materials, direct labor, and manufacturing overhead used in making its products.
• When preparing financial statements, companies need to classify costs as either product costs or period costs.
• For example, as long as the business rents space or a building, it will periodically incur rent expenses.

As the name suggests, period costs are those costs which are incurred due to the passage of time. They don’t form part of the cost of inventory and thus are expensed to the profit and loss account as and when they are incurred by the entity. Such a treatment of period costs is in accordance with the accrual concept of financial accounting. 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. 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.

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. Remember that retailers, wholesalers, manufacturers, and service organizations all have selling costs. In a manufacturing company, overhead is generally called manufacturing overhead.

For a business that does retail or wholesale, its product costs will include the cost of the supplies it purchased. If the business incurs any other costs to bring its goods to market (e.g. transportation, freight, etc.), then those are product costs too. Basically, any costs that a retailer or wholesaler incurs to acquire the goods that it will sell are product costs.

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Other companies include fringe benefit costs in overhead if they can be traced to the product only with great difficulty and effort. Research and development (R&D) costs are also period costs, particularly for innovation-driven businesses. These include salaries for research staff, experimental materials, and patent application fees. In industries like pharmaceuticals and technology, R&D can represent a significant portion of total period costs, emphasizing the role of innovation. On the other hand, period costs may include both operating and non-operating expenses (such as interest expenses).

Administrative expenses

Period costs are costs that cannot be capitalized on a company’s balance sheet. In other words, they are expensed in the period incurred and appear on the income statement. There are still some product costs that don’t rise or fall with the level of production such as the cost of renting the building that houses the production process.

This is because period costs are expenses that are not tied to the production process. Depending on whether the products are sold or unsold at the end of the period, their related product costs will either appear on the balance sheet or income statement. Based on the association with the product, cost can be classified as product cost and period cost. Product Cost is the cost that is attributable to the product, i.e. the cost which is traceable to the product and is a part of inventory values.

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Therefore, before talking about how a product cost differs from a period cost, we need to look at what the matching 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.

• According to generally accepted accounting principles (GAAPs), all selling and administrative costs are treated as period costs.
• Period costs are always recognized in profit or loss in the period in which they are incurred.
• There’s also the cost of maintaining the machinery and equipment that are used in the manufacturing process.
• Period costs are sometimes broken out into additional subcategories for selling activities and administrative activities.
• A business may spend money to acquire the materials it needs to produce a sellable product.

So, take a read of the article, that sheds light on the differences between product cost and period cost. 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. 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 product cost vs period expenses salary, and rent expense relating to a corporate office.

Product costs only include the operating cost of the business (cost of goods sold). For sold products, their costs will appear on the income statement as “cost of goods sold”. Separating the costs into various categories is often very important and, at times, useful to analyze the company’s significant cost drivers. In addition, cost analysis is critical to examine the position of the business and the amount of revenue it needs to generate to achieve economies of scale. Below is a break down of subject weightings in the FMVA® financial analyst program. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy.

Period Costs VS Product Costs

Now that we have taken a bird’s eye view of the matching principal, let’s look into the meanings of and difference between product costs and period costs. Period cost refers to the passage of time incurred by the businesses even if there is no production of goods or inventory purchase. Therefore, a period cost is generally recorded in the books of accounts with inventory assets. As the name suggests, product costs are derived from producing major types of products by the business.

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. Additional examples of period costs are marketing expenses, rent that is unrelated to a production plant, office depreciation, and indirect labor.

On the contrary, Period Cost is just opposite to product cost, as they are not related to production, they cannot be apportioned to the product, as it is charged to the period in which they arise. 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. Business often segregates these costs based on fixed, variable, direct, or indirect. Each company should ponder upon the various expenses they incur over the period, making the business more self-reliant and cost-efficient.

They don’t naturally appear on the balance sheet as they are expense accounts. For sold goods, their product costs will appear on the income statement as “cost of goods sold” which is an expense account. On the other hand, a business will always incur period costs whether or not it produces and sells goods. Depending on whether an expense is involved in the production process or not, it could be classified either as a product cost or a period cost. Direct materials are those materials used only in making the product and there is a clear, easily traceable connection between the material and the product.