Period costs: Product vs Period Costs Accounting for Managers
However, other labor, such as secretarial or janitorial staff, would instead be period costs. Overhead, or the costs to keep the lights on, so to speak, such as utility bills, insurance, and rent, are not directly related to production. However, these costs are still paid every period, and so are booked as period costs. Both product costs and period costs may be either fixed or variable in nature. 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.
They are the costs that are directly and indirectly related to producing an item. Selling expenses are costs incurred to obtain customer orders and get the finished product in the customers’ possession. Advertising, market research, sales salaries and commissions, and delivery and storage of finished goods are selling costs.
Product vs. Period Costs
Firms account for some labor costs (for example, wages of materials handlers, custodial workers, and supervisors) as indirect labor because the expense of tracing these costs to products would be too great. Indirect labor consists of the cost of labor that cannot, or will not for practical reasons, be traced to the products being manufactured. Period costs are basically the expenses which could be charged to income statement of the company for the period in which such expenses have been incurred.
So if you pay for two years of liability insurance, it wouldn’t be good to claim all of that expense in the period the bill was paid. Since the expense covers a two year period, it should be recognized over both years. Period costs and product costs are two categories of costs for a company that are incurred in producing and selling their product or service.
Considerations in Production Costs Calculations
The cash may actually be spent on an item that will be incurred later, like insurance. It is important to understand through the accrual method of accounting, that expenses and income should be recognized when incurred, not necessarily when they are paid or cash received. If you manufacture a product, these costs would include direct materials and labor along with manufacturing overhead.
Sales commissions, administrative costs, advertising and rent of office space are all period costs. These costs are not included as part of the cost of either purchased or manufactured goods, but are recorded as expenses on the income statement in the period they are incurred. If advertising happens in June, you will receive an invoice, and record the expense in June, even if you have terms that allow you to actually pay the expense in July.
Items That are Not Period Costs
SG&A includes costs of the corporate office, selling, marketing, and the overall administration of company 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. Any of these types of companies may just use the term overhead rather than specifying it as manufacturing overhead, service overhead, or construction overhead. Overhead is part of making the good or providing the service, whereas selling costs result from sales activity, and administrative costs result from running the business.
- Every cost incurred by a business can be classified as either a period cost or a product cost.
- The person creating the production cost calculation, therefore, has to decide whether these costs are already accounted for or if they must be a part of the overall calculation of production costs.
- However, the costs of machinery and operational spaces are likely to be fixed proportions of this, and these may well appear under a fixed cost heading or be recorded as depreciation on a separate accounting sheet.
- For a retailer, the product costs would include the supplies purchased from a supplier and any other costs involved in bringing their goods to market.
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. The period costs could not be capitalized as they are not directly related to the production of the inventory and hence are charged in the profit and loss statement of the company. The management of the period cost helps the company to prepare better budgeting and able the entity to use the increased profit in expanding the business through which the entity will yield more profit. 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.
Period Costs vs. Product Costs: An Overview
Most of the components of a manufactured item will be raw materials that, when received, are recorded as inventory on the balance sheet. 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 raw materials are brought in they will sit on the balance sheet.