The difference between product costs and period costs

Direct labor costs include the labor costs of all employees actually working on materials to convert them into finished goods. As with direct material costs, direct labor costs of a product include only those labor costs distinctly traceable to, or readily identifiable with, the finished product. The wages paid to a construction worker, a pizza delivery driver, and an assembler in an electronics company are examples of direct labor. Examples of product costs include the cost of raw materials used, depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance.

How confident are you in your long term financial plan?

In short, any costs incurred in the process of acquiring or manufacturing a product are considered product costs. To illustrate, assume a company pays its sales manager a fixed salary. These are more like ongoing business expenses, not tied to a particular product but necessary for keeping the lights on.

A quick look at period costs

Unlike product costs, period costs don’t linger in the inventory valuation storyline. Period costs immediately expense themselves, appearing on the income statement for the specific period they occurred. Product and period costs take part in the financial story, influencing the bottom line and revealing the business’s financial health. When you look at a business’s income statement or a balance sheet, product and period costs show up there, influencing different parts of these financial statements.

All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site.

Period costs can be defined as any cost or expense items listed in the firm’s income statement. Examples of period costs include selling and administrative expenses. Both of these types of expenses are considered period costs because they are related to the services consumed over the period in question. Product costs (direct materials, direct labor and overhead) are not expensed until the item is sold when the product costs are recorded as cost of goods sold. Period costs are selling and administrative expenses, not related to creating a product, that are shown in the income statement in the period in which they are incurred. Period costs include selling expenses and administrative expenses that are unrelated to the production process in a manufacturing business.

In a manufacturing company, overhead is generally called manufacturing overhead. (You may also see other names for manufacturing overhead, such as factory overhead, factory indirect costs, or factory burden). Service companies use service overhead, and construction companies use construction overhead.

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

1. Therefore, a period cost is generally recorded in the books of accounts with inventory assets.
2. On the other hand, period costs do not get apportioned or assigned to any unit of product.
3. Product costs are variable and fluctuate as the activity levels within a company increase or decrease.
4. Most period costs are considered periodic fixed expenses, although in some instances, they can be semi-variable expenses.
5. But you won’t be able to deduct them if you don’t know what they are.

Per-unit cost is calculated by dividing your costs by the number of units produced. It is an important metric, particularly when determining product pricing. Also, fixed and variable costs may be calculated differently at different phases in a business’s life cycle or accounting year. Whether the calculation is for forecasting or reporting affects the appropriate methodology as well. Period costs and product costs are two categories of costs for a company that are incurred in producing and selling their product or service. Product costs only become an expense when the products to which they are attached are sold.

Do you own a business?

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. These costs are identified as being either direct materials, direct labor, or factory overheads, and they are traceable or assignable to products.

Both product costs and period costs directly affect your balance sheet and income statement, but they are handled in different ways. Product costs are always considered variable costs, as they rise and fall according to production levels. 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. They are the costs that are directly and indirectly related to producing an item.

Integrate financial data from all your sales channels in your accounting to have always accurate records ready for reporting, analysis, and taxation. See it in action with a 15-day free trial or spare a spot at our weekly public demo to have your questions answered. If you’re currently in business, you need a good way to manage costs. Period costs are of no less help, as they allow you to understand how well you’re running your business. Today, we’re breaking down these two concepts to understand their general aspects, relationship with financial statements, and overall impact on business decision-making.

Let’s say you’re considering hiring more staff to handle the increasing number of orders. By looking at period costs, you can evaluate the impact of such decisions on the bakery’s overall financial health. Period costs are like the backstage crew ensuring the business show runs smoothly. Remenber, they include things like rent, salaries, and advertising costs?

Product costs help you set these prices, ensuring you cover all the expenses and have some left for profit. So, product costs become your pricing compass, guiding you to set prices that keep your bakery in business. Product cost and period cost are accounting concepts used to categorize and allocate expenses in a business. accounting ratios overview examples formulas These terms play a part in determining the cost of goods sold (COGS) and overall profitability. 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.

Difference Between Product Costs and Period Costs FAQs

Therefore, period costs consist of all items not included as product costs. These costs do not become a part of the capitalized how are the three financial statements linked cost of a specific product. Instead, companies expense out period costs each period through the income statement. This means that these costs directly impact the income statement for the specific time frame.