The difference between product costs and period costs
/What are Product Costs?
Product costs are any costs incurred in the manufacture of a product. These costs include direct materials, direct labor, and factory overhead. If the related products are sold at once, then these costs are charged to the cost of goods sold immediately. If the products are not sold right away, then these costs are instead capitalized into the cost of inventory, and will be charged to expense later, when the products are eventually sold.
What are Period Costs?
A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses. These costs tend to be clustered into the selling, general and administrative classifications of expenses, and appear in the lower half of a reporting entity’s income statement.
Comparing Product Costs and Period Costs
There are several differences between product costs and period costs, which are as follows:
Accounting treatment. Product costs are capitalized as part of inventory and appear on the balance sheet until the related products are sold. Once sold, these costs move to the income statement as part of the cost of goods sold. Conversely, period costs are immediately expensed in the income statement in the period in which they occur, impacting net income directly.
Impact on financial statements. Product costs affect both the balance sheet (as inventory) and the income statement (as cost of goods sold upon sale). Conversely, period costs impact only the income statement directly as expenses.
Relevance to manufacturing costs. Product costs are typically associated with manufacturing activities, while period costs relate to non-manufacturing activities, such as administrative functions and sales efforts.
By understanding the differences between product and period costs, businesses can more accurately manage their expenses and assess profitability.
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Examples of Product Costs and Period Costs
Examples of product costs are direct materials, direct labor, and allocated factory overhead. Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities.
Categories of Period Costs and Product Costs
Period costs are sometimes broken out into additional subcategories for selling activities and administrative activities. 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.
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.