Salary paid for the production floor manager is classified as a product cost since the cost is incurred for actual production of the product. Salary paid to an executive is a period cost, since the executive does not work directly on product production. Product costs, on the other hand, are expenses that are incurred to manufacture a good and can typically be traced back to a specific product. In other words, product costs are the expenses incurred to produce something. Raw materials and workers’ wages are good examples of product costs. The concept of product vs period costs is a subset of cost accounting.

  1. Operating expenses are costs that businesses expect to incur in their attempts to generate revenue.
  2. Examples of product costs include the cost of raw materials used, depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance.
  3. 70% of the offices are for administrative employees, and 30% are for production supervisors.
  4. The difference between what you spent to buy the inventory and what you sold it for is the profit.
  5. They are all the expenses/costs listed in a firm’s income statement.

The company has three executives who each get paid $250,000 every quarter. 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. Their selling expense is from the commission they pay their salespeople.

What are period costs?

Both of these types of expenses are considered period costs because they are related to the services consumed over the period in question. 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. Product costs are all the costs that are related to producing a good or service. They are either direct materials, direct labor or factory overhead. These items are directly traceable or assignable to the product being manufactured.

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. These costs are identified as being either direct materials, direct labor, or factory overheads, and they are traceable or assignable to products. The expenses incurred at the headquarters though can’t be attached to any vehicles because they don’t make any Fast vehicles at the headquarters! That includes the executives’ salaries and all of the expenses incurred in the support departments. Salary can be both a product cost and a period cost depending on the activities of the worker.

However, if these costs become excessive they can add significantly to total expenses and they should be monitored closely so managers can take action to reduce them when possible. Examples include production materials consumed in making a product and commissions paid to salespeople. What is paid during that period was $100,000 in rent and utilities, but only $10,000 in insurance and property taxes because a storm damaged the roof of one of its properties. During the fourth quarter of 2016, Company XYZ expected to pay $150,000 in rent and utilities and $100,000 in insurance and property taxes. Period expenses are costs that help a business or other entity generate revenue, but aren’t part of the cost of goods sold. Cost of goods sold refers to the cost of production of goods, so it is a period cost.

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A product cost is initially recorded as inventory, which is stated on the balance sheet. Once the inventory is sold or otherwise disposed of, it is charged to the cost of goods sold on the income statement. A period cost is charged to expense on the income statement as soon as it is incurred. 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. As shown in the income statement above, salaries and benefits, rent and overhead, depreciation and amortization, and interest are all period costs that are expensed in the period incurred.

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.

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

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The difference between what you spent to buy the inventory and what you sold it for is the profit. 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.

He has a CPA license in the Philippines and a BS in Accountancy graduate at Silliman University. Imagine you are the owner and co-founder of MealCo, an organic canned meals producer company. MealCo operates a small building where 40% of the area is used as offices and 60% as a production facility. 70% of the offices are for administrative employees, and 30% are for production supervisors. However, the general formula would be the sum of selling and administrative salaries, bills, and utilities. If you’re currently in business, you need a good way to manage costs.

These costs may include the cost of raw materials used in production, wages of workers who operate in producing goods, or the cost of utilities consumed by manufacturing facilities. However, you’ll still have to pay the rent on the building, pay your insurance and property taxes, and pay salespeople that sell the products currently in inventory. The one similarity among the period costs listed above is that these costs are incurred whether production has been halted, whether it’s doubled, or whether it’s running at normal speed.

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. Period costs are those costs that are not a necessary part of the process of producing a product or service to be sold. As the name implies, period costs are recorded as an expense in the income statement in the period that the cost is incurred. So, if you pay rent in June, it’s recorded in the period in which June falls.

What is the difference between product costs and period costs?

That would depend on whether the depreciation is on property and equipment related to the manufacturing process or not. 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. Production costs are usually part of the variable costs of business because the amount spent will vary in proportion to the amount produced.