Period Costs vs Product Costs: What’s the Difference?
All manufacturing expenses, costs incurred in the factory or production process, (i.e., direct materials, direct labor, and factory overhead) are product costs. Direct materials, direct labor, and factory overhead are combined to form the products to be sold, hence the term “product costs”. In general, overhead refers to all costs of making the product or providing the service except those classified as direct materials or direct labor. Manufacturing overhead costs are manufacturing costs that must be incurred but that cannot or will not be traced directly to specific units produced. In addition to indirect materials and indirect labor, manufacturing overhead includes depreciation and maintenance on machines and factory utility costs.
- Regardless of differences, both types are significant in the cost accounting and profit appropriation of a business entity.
- If a company’s management understands both product and period costs, they can use it in improving decision-making.
- As a general rule, costs are recognized as expenses on the income statement in the period that the benefit was derived from the cost.
- During the fourth quarter of 2016, Company XYZ expected to pay $150,000 in rent and utilities and $100,000 in insurance and property taxes.
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These costs are identified as being either direct materials, direct labor, or factory overheads, and they are traceable or assignable to products. Unlike product costs, period costs don’t linger in the inventory valuation storyline. Period costs immediately expense themselves, what is included in period costs appearing on the income statement for the specific period they occurred. These are more like ongoing business expenses, not tied to a particular product but necessary for keeping the lights on. Unlike product costs, period costs don’t depend on the production volume.
Product Cost vs. Period Costs: What Are the Differences?
Period costs are also an essential part of the cost and managerial accounting in any business entity. On the other hand, since product costs like office expenses, administration expenses, marketing expenses, rent, and so on cannot be linked to the cost of goods sold, they will be charged to the expense account. Period costs are the costs incurred by a company to produce goods or render services that cannot be capitalized into prepaid expenses, inventory, or fixed assets.
Product Costs
Instead, these expenses are incurred and recorded in a lump sum for the whole business entity. Some companies have a regulation to transfer some periodic costs to the product costs as a percentage of each period cost. The product costs also include the factory overhead cost that goes into manufacturing or procuring the products. Often, managers focus on the bottleneck operation, which means that their main focus is on including the direct material cost and time the product spends in the bottleneck operation. However, the managers also modify the overhead costs for short-term production or price determination. Finally, managing product and period costs will help you establish more accurate pricing levels for your products.
- Product costs are all the costs that are related to producing a good or service.
- However, the managers also modify the overhead costs for short-term production or price determination.
- 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.
- An example of a product cost would be the cost of raw materials used in the manufacturing process.
They determine the value assigned to these unsold goods on the balance sheet. Understanding period costs helps assess the day-to-day financial health of a business. And while product costs focus on the creation of goods or services, period costs represent the broader expenses necessary to sustain the business’s overall operations and facilitate growth. All the product costs are transferred to inventories before recording as the cost of goods sold in the income statement.
Period costs vs. product costs: What’s the difference?
Overhead or sales, general, and administrative (SG&A) costs are considered period costs. SG&A includes costs of the corporate office, selling, marketing, and the overall administration of company business. 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 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.