Product vs Period Costs Accounting for Managers

Breaking down your business’s costs can unearned revenue help you calculate profit more accurately as well as assist with financial forecasting. When looking at typical costs, you’ll often see these separated into product vs. period cost. In this guide, we’ll define the similarities and differences between product and period costs so that you can keep better track. Period costs are expenses that will be reported on the income statement without ever attaching to products. Since they are not product costs, period costs will not be included in the cost of inventory. Instead, period costs will be referred to as period expenses since they will be reported on the income statement as selling, general and administrative (SG&A) or interest expenses.

• Breaking down your business’s costs can help you calculate profit more accurately as well as assist with financial forecasting.
• When preparing financial statements, companies need to classify costs as either product costs or period costs.
• Labor union agreements and overtime regulations, like those under the Fair Labor Standards Act (FLSA) in the United States, can impact these costs.
• On the contrary, Period Cost is just opposite to product cost, as they are not related to production, they cannot be apportioned to the product, as it is charged to the period in which they arise.
• Therefore, period costs are only recognized as expenses in the income statement.

Difference Between Product Cost and Period Cost

This additional information is needed when calculating period costs the break even sales level of a business. It is also useful for determining the minimum price at which a product can be sold while still generating a profit. Allocation is the only way to account for overhead since we can’t pinpoint its direct relationship to products and services. Below is a simple flowchart we designed that summarizes how to distinguish period costs vs product costs. Research and development (R&D) costs are also period costs, particularly for innovation-driven businesses. These include salaries for research staff, experimental materials, and patent application fees.

• These include salaries for research staff, experimental materials, and patent application fees.
• In other words, product costs are expenses that are initially “parked” in the balance sheet and recorded only as an expense (COGS) upon sale.
• If a product is unsold, the product costs will be reported as inventory on the balance sheet.
• Being traceable means that you won’t have a hard time determining the physical quantity and its cost equivalent.
• Period costs guide decisions about how to efficiently rule your small business realm to stay afloat, impacting staffing, advertising, and day-to-day operations.

Timing of recognition as expense

In order that gross profit and net profit are appropriately reflected, it is important that costs are bifurcated correctly. When preparing financial statements, companies need to classify costs as either product costs or period costs. We need to first revisit the concept of the matching principle from financial accounting. Period costs are always recognized in profit or loss in the period in which they are incurred. In summary, product costs are recognized in the balance sheet before being expensed in the income statement.

Allocable to Products & Services

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. Moreover, period costs are expenses in the income statement of the period in which they were incurred.

Why is it important to distinguish product costs and period costs?

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. These unsold units would continue to be treated as asset until they are sold in a following year and their cost transferred from inventory account to cost of goods sold account. Examples of period costs include administrative expenses like office supplies, utilities, depreciation, and rent.

• When the product is sold, its cost is removed from inventory and will be included on the income statement as the cost of goods sold.
• The product costs are sometime named as inventoriable costs because they are initially assigned to inventory and expensed only when the inventory is sold and revenue flows into the business.
• Product costs help you fine-tune the price of each item you sell, ensuring profitability.
• This can eventually help the entity take corrective action to lower costs and improve profitability.
• So, take a read of the article, that sheds light on the differences between product cost and period cost.
• Now that we have taken a bird’s eye view of the matching principal, let’s look into the meanings of and difference between product costs and period costs.

Consequently, they are not apportioned to any product but charged as an expense in the income statement. 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 Insurance Accounting costs represent the broader expenses necessary to sustain the business’s overall operations and facilitate growth. By understanding the differences between product and period costs, businesses can more accurately manage their expenses and assess profitability. 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.