Period vs Product Cost Definition, Calculation & Examples

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. For sold goods, their product costs will appear on the income statement as “cost of goods sold” which is an expense account. To start, only businesses that produce or acquire and eventually sell goods incur product costs. We refer to these costs that are not directly related to the production of goods as period costs. Depending on the type of business, the costs/expenses that are product costs will differ.

Product costs contribute to the valuation of Ending inventory on the balance sheet

Manufacturing overhead includes things at the manufacturing plant that have to be incurred in order to get the product made, but is not part of the actual product or touches to make the product. You can not easily determine how much of these costs it takes to make one product. Are included as part of inventory and shown on the balance sheet until the product is sold. Product costs are often called “inventoriable costs” or “manufacturing costs”. 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.

• The cost of direct materials impacts inventory valuation as it represents the value of these materials that have been incorporated into finished goods.
• This timing is crucial for accurately determining the total cost of producing each unit.
• Accountants treat all selling and administrative expenses as period costs for external financial reporting.

Key considerations

To overcome this, businesses often use allocation methods to distribute these costs among different products based on certain criteria. Common allocation methods include using direct labor hours, machine hours, or material costs as a basis for distributing indirect expenses. Unlike direct expenses, indirect expenses cannot be easily attributed to a specific product or service. These costs are incurred for the overall operation of a business and are not directly tied to production activities.

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. Such materials, called indirect materials or supplies, are included in manufacturing overhead. 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. 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.

Period costs don’t impact inventory valuation

Similarly, the wages paid to the carpenters who assemble the chairs would also fall under this category. Period costs are crucial for creating operational budgets, while product costs assist in production budgeting. Product costs are recorded as inventory on the balance sheet until the product is sold. Once sold, these costs are transferred to the cost of goods sold (COGS) on the income statement. In the accounting records, the cost of finished products is accumulated in an inventory account – usually “Finished Goods Inventory”. When goods are sold, the cost is transferred from “Finished Goods Inventory” in the balance sheet to “Cost of Sales” (or Cost of Goods Sold) in the income statement.

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In this blog post, we will discuss product cost and period cost difference. This period costs vs product costs method ensures that each product bears its fair share of the overall production costs. Balancing product and period costs is important for your business performance efficiency.

Examples include selling, general and administrative (SG&A) expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office. The costs are not related to the production of inventory and are therefore expensed in the period incurred. In short, all costs that are not involved in the production of a product (product costs) are period costs.

By analogy, a manufacturer pours money into direct materials, direct labor, and manufacturing overhead. This collection of costs constitutes an asset on the balance sheet (“inventory”). This inventory remains as an asset until the goods are sold, at which point the inventory is gone, and the cost of the inventory is transferred to cost of goods sold on the income statement. Product costs are costs that are incurred to create a product that is intended for sale to customers. Product costs include direct material (DM), direct labor (DL), and manufacturing overhead (MOH). In service-based industries, revenue recognition is typically based on the completion or delivery of services to customers rather than the sale of physical products.

Is Labor a Period Cost or a Product Cost?

If the business does not own any building, then it will have to rent space to house its various non-production functions such as administration, accounting, customer service, etc. Some of the expenses that a business incurs have nothing to do with the production of goods at all. Additionally, the calculation of fixed and variable expenses may vary depending on the stage of a business’s life cycle or accounting year. The right approach will also vary depending on whether the calculation is for reporting or forecasting. Therefore, the person calculating the production costs must decide if these charges have already been taken into account or if they must be included in the total production cost estimate. By mastering the principles of cost classification, businesses can gain deeper insights into their financial health and make informed decisions that drive long-term success.

• Cost flow in service-based industries is a crucial aspect of financial management that directly impacts revenue recognition.
• CFI is on a mission to enable anyone to be a great financial analyst and have a great career path.
• They are capitalized to inventory because when a product is in the process of being manufactured, work in process costs are being incurred and value is added throughout the process, not all at once.
• Consider working with TranZact’s production management solution to improve cost control and get a competitive advantage.

Impact on the Income Statement

Executive salaries, clerical salaries, office expenses, office rent, donations, research and development costs, and legal costs are administrative costs. An example of a product cost would be the cost of raw materials used in the manufacturing process. Product costs also include Depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance. These costs are identified as being either direct materials, direct labor, or factory overheads, and they are traceable or assignable to products.

And, the relationship between these costs can vary considerably based upon the product produced. A manufacturer’s product costs are the direct materials, direct labor, and manufacturing overhead used in making its products. They are the costs that are directly and indirectly related to producing an item. Period cost (often referred to as period expense) is any other cost that is incurred by the entity that does not directly relate to the entity’s manufacturing process.

Examples of Product vs Period Costs

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. Rent can be a period cost or a product cost depending on what the rented building is used for. If the rented building is used as a manufacturing facility, it is a product cost.

Instead of being immediately expensed, product costs are capitalized, meaning they are recorded on the balance sheet as an asset. It’s only when the product is sold that these costs are transferred to the Cost of Goods Sold (COGS) category on the income statement. This approach aligns with the principle of matching expenses with revenue, providing a more accurate representation of the true cost of goods sold. Product costs are costs necessary to manufacture a product, while period costs are non-manufacturing costs that are expensed within an accounting period. The integration of period costs into budgeting and forecasting is a sophisticated exercise that enhances the precision of financial planning.

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