6 7: Product vs. Period Costs Business LibreTexts
Because of the different nature of product and period costs, they receive different accounting treatments. Product costs form part of inventory and the balance sheet, making them inventoriable cost. They only affect the income statement when inventory is sold, and the cost of inventory becomes COGS.
Period costs don’t impact inventory valuation
Otherwise, costs that can’t be traced or allocated to products and services are classified as period costs or costs that are attributed to the period in which they were incurred. Product and period costs are the two major classifications of costs period costs that have different accounting treatments. Product costs are related to the cost of purchasing inventory for sale or performing a service. Meanwhile, period costs are costs that are not related to production but are essential to the business as a whole.
What is cost of production?
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 retained earnings of these types of expenses are considered period costs because they are related to the services consumed over the period in question. If you manufacture a product, these costs would include direct materials and labor along with manufacturing overhead. 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.
Product cost:
To meet the direct cost definition, the expense should connect to core production or department operations and wouldn’t exist if the activity didn’t exist. The cost of labor is unique in that it can be both a product and period HVAC Bookkeeping 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.
Product or service pricing: indirect vs. direct costs
- In short, any costs incurred in the process of acquiring or manufacturing a product are considered product costs.
- However, you can use a cost allocation process with accounting software or an enterprise resource system to distribute expenses.
- If a manufacturer leases its manufacturing plant and equipment, the lease is a product cost (as opposed to a period cost).
- In a manufacturing organization, an important difference exists between product costs and period costs.
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. So if you sell a widget for $20 that had $10 worth of raw materials, you would record the sale as a credit (increasing) to sales and a debit (increasing) either cash or accounts receivable. The $10 direct materials would be a debit to cost of goods sold (increasing) and a credit to inventory (decreasing). The $10 direct materials would be a debit to cost of goods sold (increasing) and a credit to inventory (decreasing). Examples of product costs are direct materials, direct labor, and allocated factory overhead.
- Executive salaries, clerical salaries, office expenses, office rent, donations, research and development costs, and legal costs are administrative costs.
- These costs tend to be clustered into the selling, general and administrative classifications of expenses, and appear in the lower half of a reporting entity’s income statement.
- Direct costs are expenses with clear ties to a specific cost object, like a product, service, project, or department.
- Product cost and period cost are accounting concepts used to categorize and allocate expenses in a business.
- In the accounting records, the cost of finished products is accumulated in an inventory account — usually «Finished Goods Inventory».
- The remaining inventory of 200 units would not be transferred to cost of good sold in 2022 but would be listed as current asset in the company’s year-end balance sheet.
Product costs (also known as inventoriable costs) are costs assigned to products. Today, we’re breaking down these two concepts to understand their general aspects, relationship with financial statements, and overall impact on business decision-making. 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. 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.
Direct labor
Period costs are hard to pinpoint to the business’s main products, but they are incurred nonetheless because they’re essential. Examples of period costs include rent and utilities of admin offices, finance charges, marketing and advertising, commissions, and bookkeeping fees. Allocable but nontraceable costs to products and services—like our electricity example above—are called manufacturing overhead (MOH). We still include MOH as part of product costs even if we can’t trace them directly. Period costs appear in the income statement as operating expenses, including selling, general, and administrative (SG&A) expenses.
Period costs are not attached to products and the company does not need to wait for the sale of its products to recognize them as expense on income statement. According to generally accepted accounting principles (GAAPs), all selling and administrative costs are treated as period 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.
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