In this post, you’ll learn the key differences between period and product costs along with real-world examples to clearly illustrate the implications of proper classification. Both product costs and period costs may be either fixed or variable in nature. For a retailer, the product costs would include the supplies purchased from a supplier and any other costs involved in bringing their goods to market. In short, any costs incurred in the process of acquiring or manufacturing a product are considered product costs. Period costs are costs that cannot be capitalized on a company’s balance sheet. In other words, they are expensed in the period incurred and appear on the income statement.

Definition of Rent Expense

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. Examples of product costs are direct materials, direct labor, and allocated factory overhead. Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities. Period costs include any costs not related to the manufacture or acquisition of your product. Sales commissions, administrative costs, advertising and rent of office space are all period costs. These costs are not included as part of the cost of either purchased or manufactured goods, but are recorded as expenses on the income statement in the period they are incurred.

1. So if you pay for two years of liability insurance, it wouldn’t be good to claim all of that expense in the period the bill was paid.
2. The direct materials, direct labor and manufacturing overhead costs incurred to manufacture these 500 units would be initially recorded as inventory (i.e., an asset).
3. A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses.
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5. Product costs are used to calculate cost of goods sold and inventory value.

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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. Period costs and product costs are two categories of costs for a company that are incurred in producing and selling their product or service. Finance Strategists has an advertising relationship with some of the companies included on this website.

Comparison of Direct vs Indirect Costs in Manufacturing

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Direct costs like materials and direct labor can be easily traced to individual units of output. For example, the wood and fabric that goes into a chair, or the wages of the worker assembling it. If that reporting period is over a fiscal quarter, then the period cost would also be three months. If the accounting period were instead a year, the period cost would encompass 12 months. Also, fixed and variable costs may be calculated differently at different phases in a business’s life cycle or accounting year. Whether the calculation is for forecasting or reporting affects the appropriate methodology as well.

By understanding the key components of period costs, managers can better control overhead spending and analyze expense trends over time. Alternatively, the costs of wood, fabric, nails and other materials that physically go into building a chair are product costs. Only when the finished chair is sold does the product cost hit the income statement through cost of goods sold. Period costs and product costs are two important concepts in managerial accounting that classify costs to analyze financial performance. Examples of period expenses include vendor bills, storage for supplies or inventory not generating revenue, borrowing money to cover current costs, etc. Careful analysis of period versus product costs, combined with targeted strategies to control overhead and optimize production, can yield significant cost savings and competitive advantage.

The preceding list of period costs should make it clear that most of the administrative costs of a business can be considered period costs. They are also included in determining the amount of revenue that has been earned when an asset is sold, which in turn can affect both revenues and costs in future accounting periods. Unlike period expenses, operating expenses often cannot be easily identified by when payments are received or made during the accounting periods that they affect. Indirect costs like supervision, utilities, and equipment repairs cannot be directly linked to specific units of production. They are allocated using cost drivers like machine hours, square footage, labor hours, etc.

In manufacturing companies, theses costs usually consist of direct materials, direct labor, and manufacturing overhead cost. In summary, proper classification of costs as either product or period expenses is vital for financial reporting accuracy and strategic business management. Companies that develop strong costing systems and discipline around classifications is rent a period cost put themselves in a superior competitive position. The type of labor involved will determine whether it is accounted for as a period cost or a product cost.