Understanding the difference between product costs vs. period costs is essential. These terms, product cost, and period cost, play a key role in financial management and reporting. But what exactly sets them apart?
In this article, we will discuss the differences between product costs vs. period costs and gain insight into their unique roles in business accounting and operations. Discover how knowing the concept of product costs vs. period costs can greatly impact your financial strategies and decision-making, clarifying what defines a period cost and why it's a crucial element in financial planning.
Product Costs vs Period Costs: Difference Between Product Costs and Period Costs
Here's a list of key differences while comparing the Product and period costs:
| Attribute | Product cost | Period Cost |
|---|---|---|
| Meaning | Product Cost is the cost that can be allocated to the product. | Period cost, also known as an operating expense or non-manufacturing cost, is a type of expense incurred by a business that is not directly tied to producing goods or services. |
| Calculated on | Volume | Time |
| Nature | Product cost is a variable cost because it mostly depends on the production volume. | Period cost is a fixed cost, like rent, salaries, maintenance, etc., and is revised yearly. |
| Are these costs included in inventory valuation? | Yes | No |
| Includes | Production or Manufacturing Cost | Non-manufacturing costs, such as selling and distribution, office and administration, etc. |
| Part of the Cost of Production | Yes | No |
| Examples | Raw material costs, production expenses, machinery depreciation, labor costs, etc. | Payroll, rent, audit fees, office asset depreciation, etc. |
While comparing the difference between product cost and period cost, it becomes clear that these two accounting categories have different purposes within a company's financial structure.
What Is a Product Cost?
The direct expenses incurred in the production of a product are referred to as product costs. For instance, a manufacturer's product costs can include:
- Raw materials
- Costs directly related to the producing facility, like electricity
- Manufacturing supplies
- Direct labor
To put it simply, a product's costs are any costs involved during its purchase or manufacturing.
Product costs are frequently considered inventory and are known as "inventoriable costs" since they are used to calculate the inventory's value. The product costs are included in the costs of goods sold, which are listed in the income statement when products are sold.
What Is a Period Cost?
All costs that are not included in product costs are referred to as period costs; costs throughout a certain manufacturing period that are not directly related to the production process.
Overhead and sales, general, and administrative (SG&A) costs are part of the period costs. SG&A (selling, general, and administrative expenses) includes expenses for the corporate office, marketing, sales, and general business administration.
Period costs are not connected to a particular product or the cost of inventory, similar to product costs. Period costs are, therefore, recorded as an expense in the accounting period in which they occurred.
Additional examples of period costs are marketing expenses, rent that is unrelated to a production plant, office depreciation, and indirect labor. The interest a business pays on its loan would additionally be considered a period cost.
Considerations in Production Costs Calculations
Both product cost and period cost may be either variable or fixed in nature.
- Production costs are typically included in a company's variable costs because the amount spent will vary according to the amount of goods generated.
- The expenses of equipment and workspaces are fixed elements of the production process. They will appear under a heading for fixed costs or as depreciation on a different accounting sheet.
Therefore, the person calculating the production costs must decide if these charges have already been taken into account or if they must be included in the total production cost estimate.
Additionally, the calculation of fixed and variable expenses may vary depending on the stage of a business's life cycle or accounting year. The right approach will also vary depending on whether the calculation is for reporting or forecasting.
Examples of Product Costs and Period Costs
Direct materials, direct labor, and the cost of factory overhead are a few examples of product costs. Period cost examples include general and administrative expenses such as rent, office depreciation, office supplies, and utilities.
Maximizing Profitability With TranZact's Cost Management Solutions
It is a financial exercise and a strategic need to divide costs into various categories, such as product costs vs. period costs. By studying these cost factors, businesses can make educated decisions, improve processes, and increase profits.
Consider working with TranZact's production management solution to improve cost control and get a competitive advantage. TranZact gives Indian SME Manufacturers the resources, analysis, and business intelligence reports they need to succeed in the market. Therefore, helping in making wise decisions and taking charge of your costs for a more profitable business is very important.
FAQs
1. For How Long Are Period Costs Recorded?
Period costs are recorded for the specific accounting period in which they are incurred. For example, if a company incurs advertising expenses, such as the cost of running a marketing campaign, those costs would be recorded as period costs for the month or quarter in which the campaign took place.
2. Why Is Overhead a Period Cost?
Due to its support for continuous business operations and lack of a clear connection to creating goods produced, overhead is considered a period cost.
3. Is Labor a Period Cost or a Product Cost?
Both period costs and product costs might include labor. Wages for administrative employees are period costs, whereas direct labor tied to production is a product cost.
4. Is depreciation a period cost?
When depreciation applies to assets like office equipment, it is considered a period expense. However, when it is used for manufacturing equipment, it becomes a portion of the product cost.
5. How do product costs and period costs affect financial statements?
Product costs directly impact a company's income statement, affecting the cost of goods sold (COGS). Period costs, on the other hand, impact the operating expenses section.
6. Why is it important to distinguish between product costs and period costs?
For proper financial reporting and to successfully determine revenue, pricing strategies, and cost control methods, it is necessary to distinguish between product costs and period costs.
