What are Product Costs?
Product costs are any costs incurred in the manufacture of a product. These costs include direct materials, direct labor, and factory overhead.
What are Period Costs?
A period cost is any cost consumed during a reporting period that has not been capitalized into inventory, fixed assets, or prepaid expenses.
Comparing Product Costs and Period Costs
The key difference between product costs and period costs is that product costs are only incurred if products are acquired or produced, and period costs are associated with the passage of time. Thus, a business that has no production or inventory purchasing activities will incur no product costs, but will still incur period costs.
Product costs are initially recorded within the inventory asset. Once the related goods are sold, these capitalized costs are charged to expense. This accounting is used to match the revenue from a product sale with the associated cost of goods sold, so that the entire effect of a sale transaction appears within one reporting period’s income statement.
Examples of Product Costs and Period Costs
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.
Categories of Period Costs and Product Costs
Period costs are sometimes broken out into additional subcategories for selling activities and administrative activities. Administrative activities are the most pure form of period costs, since they must be incurred on an ongoing basis, irrespective of the sales level of a business. Selling costs can vary somewhat with product sales levels, especially if sales commissions are a large part of this expenditure.
Product costs are sometimes broken out into the variable and fixed subcategories. This additional information is needed when calculating 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.
Period Costs vs. Product Costs: An Overview
Period costs and product costs are two categories of costs for a company that are incurred in producing and selling their product or service. Below, we explain each and how they differ from one another.
Key Takeaways
- Product costs are those directly related to the production of a product or service intended for sale.
- Period costs are all other indirect costs that are incurred in production.
- Overhead and sales and marketing expenses are common examples of period costs.
Product Costs
Product costs are the direct costs involved in producing a product. A manufacturer, for example, would have product costs that include:
- Direct labor
- Raw materials
- Manufacturing supplies
- Overhead that is directly tied to the production facility such as electricity
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.
Product costs are often treated as inventory and are referred to as "inventoriable costs" because these costs are used to value the inventory. When products are sold, the product costs become part of costs of goods sold as shown in the income statement.
Period Costs
Period costs are all costs not included in product costs. Period costs are not directly tied to the production process. Overhead or sales, general, and administrative (SG&A) costs are considered period costs. SG&A includes costs of the corporate office, selling, marketing, and the overall administration of company business.
Period costs are not assigned to one particular product or the cost of inventory like product costs. Therefore, period costs are listed as an expense in the accounting period in which they occurred.
Other examples of period costs include marketing expenses, rent (not directly tied to a production facility), office depreciation, and indirect labor. Also, interest expense on a company's debt would be classified as a period cost.
Considerations in Production Costs Calculations
Both product costs and period costs may be either fixed or variable in nature.
Production costs are usually part of the variable costs of business because the amount spent will vary in proportion to the amount produced. However, the costs of machinery and operational spaces are likely to be fixed proportions of this, and these may well appear under a fixed cost heading or be recorded as depreciation on a separate accounting sheet.
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.
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.
For How Long Are Period Costs Recorded?
A period cost corresponds with a particular accounting period. 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.
Why Is Overhead a Period Cost?
Period costs do not directly relate to production. Overhead, or the costs to keep the lights on, so to speak, such as utility bills, insurance, and rent, are not directly related to production. However, these costs are still paid every period, and so are booked as period costs.
Is Labor a Period Cost or Product Cost?
The type of labor involved will determine whether it is accounted for as a period cost or a product cost. Direct labor that is tied to production can be considered a product cost. However, other labor, such as secretarial or janitorial staff, would instead be period costs.