Product Costs vs Period Costs0
Once the inventory is sold or otherwise disposed of, it is charged to the cost of goods sold on the income statement. A period cost is charged to expense on the income statement as soon as it is incurred. Period costs reduced net income when they are expensed on the income statement.
What are product costs and period costs?
Product costs are costs necessary to manufacture a product, while period costs are non-manufacturing costs that are expensed within an accounting period. Raw material, wages on labor, production overheads, rent on the factory, etc. Marketing costs, sales costs, audit fees, rent on the office building, etc.
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Using variable costing, fixed manufacturing overhead is reported as a period cost. Figure 6.8 “Absorption Costing Versus Variable Costing” summarizes the similarities and differences between absorption costing and variable costing. Thus, it is fair to say that product costs are the inventoriable manufacturing costs, and period costs are the nonmanufacturing costs that should be expensed within the period incurred. This distinction is important, as it paves the way for relating to the financial statements of a product producing company. And, the relationship between these costs can vary considerably based upon the product produced. By analogy, a manufacturer pours money into direct materials, direct labor, and manufacturing overhead.
These costs do not logically attach to inventory and should be expensed in the period incurred. Given that many materials go into the production of goods and services, it is important that strict measures are put in place to monitor different materials as they are purchased at varying different amounts. For a company that uses direct period costs costs, standard inventory valuation measurement must be used to avoid miscalculation of items which will affect the direct costs of production. Manufacturing costs are recorded as an asset on the balance sheet in the form of inventory. When the goods are sold, these costs are recorded on the income statement as an expense.
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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. When the product is manufactured and then sold a corresponding amount from the inventory account will be moved to the income statement.
The company rents offices for their executives and marketing team. The company manufactured and sold 1,000 cars during the fourth quarter. Each car costs $10,000 in direct materials, $10,000 in direct labor, and $20,000 in manufacturing overhead. The company has three executives who each get paid $250,000 every quarter.
Accounting for Managers
Your rent, salaries, fringe benefits, insurance, etc. are constant each month. Much of your focus is on growing your business and controlling your direct costs but your period expenses can be an area providing significant savings. While these expenses are logically linked to products, they are still period costs because they can be separated from the inventory purchasing and production process. If your company makes men’s dress shoes, your direct materials are shoelaces, rubber, and leather.
- Second, determine if the expense was incurred during that accounting period.
- Period costs are not assigned to one particular product or the cost of inventory like product costs.
- The company rents offices for their executives and marketing team.
It is an important metric, particularly when determining product pricing. Salary can be both a product cost and a period cost depending on the activities of the worker. Salary paid for the production floor manager is classified as a product cost since the cost is incurred for actual production of the product. Salary paid to an executive is a period cost, since the executive does not work directly on product production.
What is the benefit of classifying costs as products or periods?
Second, determine if the expense was incurred during that accounting period. Ask yourself if the expense was used for production or if it could be a period cost. Prepare a traditional income statement assuming the company uses absorption costing. A direct costs are costs that can be directly linked or traced to the production of a particular item.