Period Costs Definition, Example, Impact on Income Statement

So, take a read of the article, that sheds light on the differences between product cost and period cost. All types of costs are used to prepare the income statement, cash flow, and balance sheet. However, the handling of all costs in each financial statement is different. In this article, we will differentiate between the product costs and period costs for any business entity.

From the above description, we can conclude that the cost due to the manufacturing unit is product cost, and the cost other than product cost is a period cost. Period cost is not in a straight line with the production of the end product. This period cost is not assigned to the products and is recorded on the income statement for the period they incurred.

Other costs

For this reason, businesses expense period costs in the period in which they are incurred. Accountants treat all selling and administrative expenses as period costs for external financial reporting. Product costs are initially attached to product inventory and do not appear on income statement as expense until the product for which they have been incurred is sold and generates revenue for the business. When the product is sold, these costs are transferred from inventory account to cost of goods sold account and appear as such on the income statement of the relevant period. For example, John & Muller company manufactures 500 units of product X in year 2022. Out of these 500 units manufactured, the company sells only 300 units during the year 2022 and 200 unsold units remain in ending inventory.

Point-of-care tests can lower health-care costs, reduce waiting times, speed up initiation of and increase the accuracy of treatment, and improve patient follow-up. Period cost vs Product cost is nothing but the expenses in the company, and any management of a company wants a separate measurement cost because any business cost is a major concern. The cost of any product is classified into Period cost and Product cost based on its relation with the products. As a general rule, costs are recognized as expenses on the income statement in the period that the benefit was derived from the cost. 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. Since the expense covers a two year period, it should be recognized over both years.

Accounting Treatment of Product and Period Cost

Before you even begin developing a product, you need a clear plan for what you’re building. Without a project plan or product roadmap, it’s hard to make sure all stakeholders and teams are on the same page. Evaluating your expenses can help you determine whether you’re getting the most value out of them or need to consider alternatives.

• Countries with good STI surveillance, such as the United States of America and United Kingdom, are reporting increasing STIs.
• Product costs are always considered variable costs, as they rise and fall according to production levels.
• All the periodic costs of a business entity are recorded in the income statement under the head of operational costs.
• Commercial entities regularly incur different types of costs while carrying out their business activities.

For example, iron ore is a direct material to a steel company because the iron ore is clearly traceable to the finished product, steel. In turn, steel becomes a direct material to an automobile manufacturer. Based on the association with the product, cost can be classified as product cost and period cost.

Product cost is a variable cost incurred by a company or business entity to procure the merchandise or manufacture the finished goods. The retail company will record the cost of acquiring merchandise as the product cost. However, a manufacturing company’s material, labor, and FOH cost will be treated as the product cost. Salaries of administrative employees are considered fixed and period costs as well. Since admin employees aren’t directly involved in production, their salaries are period costs.

Service companies use service overhead, and construction companies use construction overhead. Any of these types of companies may just use the term overhead rather than specifying it as manufacturing overhead, service overhead, or construction overhead. Overhead is part of making the good or providing the service, whereas selling costs result from sales activity, and administrative costs result from running the business. All the period costs are recorded in the income statement and cash flow statement of the company.

Period Costs vs. Product Costs: An Overview

Additionally, the company employs one lawyer who gets paid $75,000 every quarter, and one accountant who gets paid $75,000 every quarter. Also, they spent $1,000,000 on market research and $1,000,000 to boost brand awareness during the fourth quarter. This company has $3,400,000 in period costs for the fourth quarter from their selling, marketing, and administrative expenses.

Under different costing system, product cost is also different, as in absorption costing both fixed cost and variable cost are considered as Product Cost. On the other hand, in Marginal Costing only the variable cost is regarded as product cost. An example of such cost is the cost of material, labour, and overheads employed in manufacturing a table.

Key Differences Between Product Cost and Period Cost

In financial accounting, product costs are initially carried as inventory in the books and are reflected as a current asset in the balance sheet. Once the goods are sold, the inventory is charged to the trading account in the form of cost of goods sold. This treatment of capitalizing the costs first and hsa contribution limits 2019 and more hsa rules you need to know then charging as an expense is in line with the matching principle of accounting. Thus, the product costs are expensed out as cost of goods sold only when the related income from sale of goods is realized and recorded. Product costs are also often termed as inventoriable costs and manufacturing 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).

By virtue of this concept, period costs are also recorded and reported as actual expenses for the financial year. The administration of the business entity is working throughout the year. The marketing, promotion, and sales budget is also allocated for a specific period.

Conversely, a steel mill may have high inventory costs, but low selling expenses. Many employees receive fringe benefits paid for by employers, such as payroll taxes, pension costs, and paid vacations. These fringe benefit costs can significantly increase the direct labor hourly wage rate.

Period costs and product costs are two categories of costs for a company that are incurred in producing and selling their product or service. Period costs may be further classified into selling costs and administrative costs. Every day, more than 1 million new sexually transmitted infections (STIs) are acquired, posing a significant global health challenge. However, monitoring and understanding the trends of new STIs in low- and middle-income countries (LMIC) are hindered by limited access to diagnostic tests.

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. Accurate measurement of product and period costs helps you report the correct amount of expense in the income statement and assets in the balance sheet. Failing to distinguish between product vs period costs could result in an overstatement or understatement of assets and net income. Let’s discuss the accounting treatment of product costs and period costs in greater detail. On the other hand, period costs are considered indirect costs or overhead costs, and while they play an important role in your business, they are not directly tied to production levels.