The main purpose of starting and running a business is to make a profit.
However, in pursuing such profits, a company inevitably has costs.
For example, if a company manufactures its own products, it must spend money to buy the necessary materials for production.
In addition, the company must pay the people who convert the materials into salable goods.
Added to this are the costs of maintaining the machinery and equipment used in the manufacturing process.
The point is that a company incurs costs in order to make a profit.
Some of the expenses incurred by a business have nothing to do with the production of goods.
Nonetheless, they are necessary and often unavoidable expenses.
It is the salaries and wages of managers, clerks and other employees who do not participate in the production process.
If the company does not have buildings, it must rent a space to house its various non-productive functions such as administration, accounting, customer service, etc.
There are also maintenance and additional costs.
Depending on whether an expense is related to the production process or not, it can be classified as a product cost or a period cost.
In this article, we will discuss the differences between the two.
What are the characteristics of a period fee?
What about the cost of a product?
Do all businesses incur these two types of costs or expenses?
We will try to answer these questions as we go through the article.
We will also have exercises to deepen our understanding of period cost and product cost.
What are product costs?
A business can spend money to purchase the materials needed to produce a salable product.
Additionally, there is also the cost of converting these materials into your product offerings.
We call those costs that are directly associated with the production or procurement of goods product costs.
Depending on the type of business, the costs/expenses, which are product costs, are different.
For a company that manufactures its own products, product costs typically include:
- raw materials
- Direct working
- Indirect Manufacturing Costs
- Indirect materials (e.g. glue, lubricant, oil, etc.)
- indirect work(for example, the salary or salary of the factory manager)
- Costs incurred in operating the building housing production functions (e.g. utility costs, cleaning costs, etc.)
- Cost of maintaining machinery and equipment to ensure it is in optimal condition
- Depreciation of property, plant and equipment involved in the manufacturing process
For a business that sells retail or wholesale, product cost includes the cost of consumables purchased. If the company incurs additional costs to bring its products to market (e.g. transport, freight, etc.), these are also product costs. Basically, any cost that a retailer or wholesaler incurs in purchasing the goods they sell is a product cost.
A company that does not sell products has no product costs.
Depending on whether the products are sold or not at the end of the period, the corresponding product costs appear in the balance sheet or income statement.
For unsold products, their cost appears on the balance sheet as "Inventory".
That's why we sometimes refer to product costs as inventory costs.
For goods sold, your cost appears on the Profit and Loss Account as “Cost of Goods Sold”.
What are period costs?
A company can incur costs whether it produces goods or not.
For example, if a company rents premises to house its accounting function, it will incur the rental cost whether or not it produces goods.
We call period costs those costs that are not directly related to the production of goods.
One of the reasons we call them that is because they are costs that a business typically incurs each period. For example, if the company rents space or buildings, rental costs are incurred periodically.
Common examples of period costs are:
- Salaries and salaries of administrative staff (e.g. administrative staff, human resources staff, accounting staff, etc.)
- Cost of renting the space or building that houses the non-productive functions (e.g. administration, accounting, customer service, etc.)
- distribution costs, such as B. Sales Commissions.
- exam fees
- legal fees
- Financing expenses (e.g. interest expenses)
- General and administrative expenses
- marketing and advertising costs
- travel and entertainment expenses
- expenses for office supplies
- Managerial and administrative salaries and benefits
The period cost cannot be tied to a specific product.
Like fairy tales, they are not inventoryable.
They always appear on the income statement as long as they are incurred by the company.
All businesses, whether they buy/produce goods or not, will incur expenses during their operational lifetime.
Period costs include operating and non-operating expenses.
Period costs vs. product cost
Now that we've discussed period and product costs, it's time to identify the differences between them.
First of all, only companies that produce or buy and eventually sell goods incur product costs.
Companies that do not sell products do not incur product costs.
On the other hand, a company always incurs period costs, regardless of whether it produces and sells goods or not.
Because period costs are expenses that are not related to the production process.
Product costs may appear on the balance sheet or income statement depending on whether the related goods were sold or unsold at the end of the period.
For unsold goods, your product cost appears on the balance sheet as "Inventory," which is an asset account.
For goods sold, your product cost appears on the income statement as "cost of goods sold," which is an expense account.
On the other hand, period costs always appear on the income statement. They don't appear on the balance sheet, of course, since they're expense accounts.
The product cost includes only the company's operating costs (manufacturing costs).
On the other hand, period costs can include both operating and non-operating expenses (such as interest expense).
Examples of business expenses are wages and salaries of office staff, expenses for office supplies, etc.
Both period cost and product cost can be variable or fixed (or even mixed).
The product cost is usually variable as it depends on the company's production process.
The higher the production volume, the higher the product cost.
There are still some product costs that do not increase or decrease with production levels, such as B. the cost of renting the building that houses the production process.
Period costs are usually fixed, but can sometimes be variable.
Period cost vs. product cost: exercise
Identify if the following are outputsperiod costsor product cost:
- Compensation and salaries of office workers
- Transport costs to bring the goods to the market
- Factory manager salary
- Cost of renting the building in which theaccounting function
- Direct working
- raw materials
- Cost of office staff consumables
- Cost of inputs used in the production process
- Manager's Salary.
- Salary of the General Manager
Answers: 1st period cost, 2nd product cost, 3rd product cost, 4th period cost, 5th product cost, 6th product cost, 7th period cost, 8th product cost, 9th product cost, 10th period cost
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Louisiana State University"Period costing versus product costing.white book. October 10, 2022
Product costs are those directly related to the production of a product or service intended for sale. Period costs are all other indirect costs that are incurred in production. Overhead and sales and marketing expenses are common examples of period costs.Is cost of goods a product cost or a period cost? ›
As firstly it was a product cost but as products are sold and with revenue recognized we have to record matching costs as well for the period i.e product cost. Therefore, cost of goods sold is now a period cost as well.Which of the following is an example of a period cost rather than a product cost? ›
Correct answer: Option (b)wages of salespersons is the correct answer.What can be both period and product cost? ›
The cost of labor is unique in that it can be both a product and period cost. This depends on whether the labor is directly related to production or not – a factory worker's wages would be product costs, while a company secretary's wages would be period costs.Why is it important to differentiate between product and period costs? ›
The distinction between product costs and period costs is important to: Properly measure a company's net income during the time specified on its income statement, and. To report the proper cost of inventory on the balance sheet.What are period costs examples? ›
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.What is period cost also known as? ›
Period costs are expenses that businesses add to their income statements. You may also refer to these costs as period expenses, time costs, capacity costs and operating expenses.Is rent a period or product cost? ›
Expenses and rent fall under period costs, while product costs comprise the resources for production, such as labor and materials. Results: Product costs account for the result of the products made, which is the costs of goods sold.Which of the following costs is not considered to be a period cost? ›
The correct answer is d. Freight paid on a purchase of raw materials. Since this covers the cost of something that will be used in production, it is a product cost, rather than a period cost.Can you differentiate the three types of product cost? ›
Example of Product Costs
Its product costs may include: Direct material: The cost of wood used to create the tables. Direct labor: The cost of wages and benefits for the carpenters to create the tables. Manufacturing overhead (indirect material): The cost of nails used to hold the tables together.
The correct answer is D.
Cost accountant's salary is not considered product cost because product cost is those expenses incurred in the production process of a product sold to the customers. Direct material, direct labor, and manufacturing overhead are all included in product costs.
Explain why product costs are capitalized but period costs are expensed in the current accounting period. Product costs are capitalized because it reflects the company's future value, while period costs are expanded because they are used during the current period.Are period costs part of cost of goods sold? ›
A period cost is charged to expense in the period incurred. This type of cost is not included within the cost of goods sold on the income statement. Instead, it is typically included within the selling and administrative expenses section of the income statement.Is transportation in a product or period cost? ›
These cost include the delivery charge and other expenses incurred. Transportation out is considered as an expense outright and is presented in the income statement. This cost is not capitalized, thus, considered as period cost.Are product costs always expensed in the period in which they are incurred? ›
Period costs are always expensed on the income statement during the period in which they are incurred. In sum, product costs are inventoried on the balance sheet before being expensed on the income statement. Period costs are just expensed on the income statement.What are the three major types of product costs in a manufacturing company? ›
The three general categories of costs included in manufacturing processes are direct materials, direct labor, and overhead.Is fixed manufacturing overhead a product cost? ›
In economics, production costs involve a number of costs that include both fixed and variable costs. Fixed costs are costs that do not change when output changes. Examples include insurance, rent, normal profit, setup costs and depreciation. Another name for fixed costs is overhead.What are the consequences from a company who incorrectly classify product cost as a period cost? ›
Period costs that are incorrectly classified as product costs will increase the profitability for a particular reporting period and overstate the value of inventory on the balance sheet.What are the three categories of period costs? ›
As a general rule, companies can divide period costs into three main categories being sales, general and administrative costs (SG&A costs). SG&A costs include marketing and sales expenses, corporate office and general expenses plus administrative costs.How do you calculate period costs? ›
Period costs are costs that are not incurred in the manufacturing of a product. The formula for period costs is simply adding up all costs that are classified as period costs.
Once an item is sold, the product cost, including inventory cost, becomes the cost of sold and is reported on the income statement as cost of goods sold under current expenses. Period cost is an expense and is reported for the accounting period when it occurs under current expenses on the business's income statement.What is the difference between a product cost and a period cost quizlet? ›
A product cost is a cost that is part of the inventory. A period cost is a cost that is not part of the inventory.Is R&D a period cost? ›
Research and development or R&D costs are directly tied to the COGS of specific products and treated as overhead costs. Charging this overhead cost to the COGS of the recent period and considered as period cost. Thus, all the research and development or R&D costs are treated as period costs.What are period costs called in ABC costing? ›
The period costs include selling, general, and administrative items that are charged against income in the period incurred. Product costs are the familiar direct materials, direct labor, and factory overhead. These costs are traced/allocated to production under both job and process costing techniques.Which of the following is considered a product cost? ›
Product cost refers to the costs incurred to create a product. These costs include direct labor, direct materials, consumable production supplies, and factory overhead.Are property taxes a period cost? ›
The property taxes for the office building for instance will be a period cost.Is warehouse rent a period cost? ›
Rent expense is a type of fixed operating cost or an absorption cost for a business, as opposed to a variable expense. The costs that are not included in product costs are known as period costs.Shall freight in be considered a period cost instead of product cost? ›
This statement is false because on the side of the selling company, the freight costs in shipping products to customers are recorded as period costs, which is recorded as freight out or delivery expense to be specific, not a product costs. Period costs are costs incurred not related to the production.Are all period costs fixed or variable? ›
Most period costs are considered periodic fixed expenses, although in some instances, they can be semi-variable expenses. For example, you receive a utility bill each month that is not directly tied to production levels, but the amount can vary from month to month, making it a semi-variable expense.What are the 3 costing methods? ›
The main costing methods available are process costing, job costing, direct costing, and throughput costing. Each of these methods applies to different production and decision environments.
Which of the following is true about product and period costs? - Product costs are usually manufacturing costs, and period costs are usually nonmanufacturing costs.What are the two methods of by product costing? ›
There are two ways of accounting for a by-product: the production method and the sales method. Under the production method, a product's sales value is recognised in the accounting period in which the product is produced, and the by-product is considered as inventory.Is a factory supervisor salary a product cost? ›
Examples of manufacturing product costs are raw materials used, direct labor, factory supervisor's salary, and factory utilities. In a manufacturing company, product costs are also called manufacturing costs.How do you determine what costs are expensed versus capitalized? ›
When to Capitalize vs. Expense a Cost? The Capitalize vs Expense accounting treatment decision is determined by an item's useful life assumption. Costs expected to provide long-lasting benefits (>1 year) are capitalized, whereas costs with short-lived benefits (<1 year) are expensed in the period incurred.Are product costs capitalized or expensed? ›
Definition: A product cost is an expense incurred to produce a product that is capitalized as inventory. In other words, this costs provide are necessary to manufacturer a finished good and are capitalized on the balance sheet because they provide a future benefit.What happens if you expense instead of capitalize? ›
Limitations of Capitalizing
However, financial statements can be manipulated—for example, when a cost is expensed instead of capitalized. If this occurs, current income will be understated while it will be inflated in future periods over which additional depreciation should have been charged.
The correct answer is (e) Freight out. Freight out or delivery expense is not a product cost because it was not incurred related to the production of the company's finished goods.Is equipment a period or product cost? ›
What are Product Costs or Manufacturing Costs? Product or manufacturing costs are all costs related to the production of goods. This might include material costs, wages, equipment and facilities, and commissions.Is freight in a product cost? ›
Freight-in is part of the production process and will be capitalized into inventory and expensed through cost of goods sold when the product is sold. Freight-in is the cost incurred to ship finished goods to a distributor or retailer. Freight-out is considered a selling expense and is expensed when incurred.Is transportation an expense or funding? ›
Transportation expenses are a subset of travel expenses, which include all of the costs associated with business travel such as taxi fare, fuel, parking fees, lodging, meals, tips, cleaning, shipping, and telephone charges that employees may incur and claim for reimbursement from their employers.
The distinction between product costs and period costs is important to: Properly measure a company's net income during the time specified on its income statement, and. To report the proper cost of inventory on the balance sheet.At what stage are product costs expensed? ›
If a cost is incurred to acquire or produce a product that will ultimately be sold, then the cost should be recorded as an expense when the sale takes place because that is when the benefit occurs. These costs are called product costs.At what point do product costs appear as an expense on the income statement? ›
Product costs are recorded as an asset on the balance sheet until the products are sold, at which point the costs are recorded as an expense on the income statement.What is the difference between product cost and product price? ›
Cost is typically the expense incurred for making a product or service that is sold by a company. Price is the amount a customer is willing to pay for a product or service. The cost of producing a product has a direct impact on both the price of the product and the profit earned from its sale.What is the difference between prime cost and product cost? ›
Prime costs are the combination of the two direct product costs: direct materials costs and direct labor costs. Conversion costs include the manufacturing costs that are needed to convert direct materials into final products: direct labor costs and manufacturing overhead costs.What is the cost of a product? ›
What is a Product Cost? Product cost refers to the costs incurred to create a product. These costs include direct labor, direct materials, consumable production supplies, and factory overhead. Product cost can also be considered the cost of the labor required to deliver a service to a customer.What is the major difference between the AP price and the EP cost? ›
What is the major difference between the AP price and the EP cost? AP price- The as purchased price or initial price. EP cost- the final cost to you of providing a finished dinner. the final cost to you of providing a finished dinner.How do you calculate period cost? ›
What is the formula for period cost? Period costs are costs that are not incurred in the manufacturing of a product. The formula for period costs is simply adding up all costs that are classified as period costs.How do you calculate product cost? ›
- Direct Labor + Direct Material + Factory Overheads = Product Cost Formula.
- Indirect Labor + Indirect Material + Other Factory OH = factory OH.
- Cost per unit of the product (Total Product Cost) / Number of Units Produced = Product Cost per Unit Formula.
Utilities: Expenses such as gas and electric are considered a period cost, unless they directly involve the manufacturing plant. Like rent, if administrative and factory facilities are under one roof, utility costs must be allocated according to the space used by each.
The three general categories of costs included in manufacturing processes are direct materials, direct labor, and overhead.What are the 3 costs included in product costs? ›
In general, three types of expenses are included in the cost of products: the cost of direct materials, direct labor costs and manufacturing overhead costs.What is not included in product cost? ›
The selling, general, administrative (SG&A) and interest costs of a retailer and/or a manufacturer are not product costs.