To quickly identify if a cost is a period cost or product cost, ask the question, “Is the cost directly or indirectly related to the production of products? If the cost didn’t pass the traceability test, it is an overhead cost. Allocation is the only way to account for overhead since we can’t pinpoint its direct relationship to products and services. Product and period costs are incurred in the production and selling of a product.

• They are allocated using cost drivers like machine hours, square footage, labor hours, etc.
• It’s like finding the right balance to make good products and keep the entire business in good shape.
• Breaking down your business’s costs can help you calculate profit more accurately as well as assist with financial forecasting.
• This approach aligns with the principle of matching expenses with revenue, providing a more accurate representation of the true cost of goods sold.
• As a non-cash expense, depreciation appears on the income statement but does not directly drain cash flow.

In a nutshell, we can say that all the costs which are not product costs are period costs. The simple difference between the two is that Product Cost is a part of Cost of Production (COP) because it can be attributable to the products. On the other hand Period, the cost is not a part of the manufacturing process, and that is why the cost cannot be assigned to the products. According to the Matching Principle, all expenses are matched with the revenue of a particular period. So, if the revenues are recognised for an accounting period, then the expenses are also taken into consideration irrespective of the actual movement of cash.

Period Costs vs. Product Costs: An Overview

They’re often broken down into subcategories of fixed and variable costs, which can be used for calculating things like the break-even point. When a company sells its products, the product costs form part of the cost of goods sold (COGS) on the income statement. As the name suggests, period costs are those costs which are incurred due to the passage of time. They don’t form part of the cost of inventory and thus are expensed to the profit and loss account as and when they are incurred by the entity. Such a treatment of period costs is in accordance with the accrual concept of financial accounting. For proper financial reporting and to successfully determine revenue, pricing strategies, and cost control methods, it is necessary to distinguish between product costs and period costs.

• While variable costs like materials rise and fall with production volume, fixed expenses like depreciation, rent, insurance, etc. remain unchanged from month to month.
• In this article, we will discuss the differences between product costs vs. period costs and gain insight into their unique roles in business accounting and operations.
• Failing to distinguish between product vs period costs could result in an overstatement or understatement of assets and net income.
• Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

SG&A includes costs of the corporate office, selling, marketing, and the overall administration of company business. The costs that are not classified as product costs are known as period costs. These costs are not part of the manufacturing process and are, therefore, treated as expense for the period in which they arise. Period costs are not attached to products and the company does not need to wait for the sale of its products to recognize them as expense on income statement.

Strategies for Successful Production Planning in a Changing Manufacturing Landscape

While product costs are often variable as they directly relate to the quantity of units produced, things like operational spaces and machinery maintenance can be fixed. Period costs describe a business’s additional costs incurred during a specific reporting period. While they still form part of the overall cost of running a business, they aren’t turbo tax and form 8606 directly related to manufacturing a specific good or service. Instead, they are capitalized as assets on the balance sheet as part of inventory. Only when inventory is sold are these costs transferred to the income statement as COGS. Because period costs immediately impact net income, managing them helps businesses increase profitability.

Product vs. Period Costs

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.

What is the benefit of classifying costs as products or periods?

Additional examples of period costs are marketing expenses, rent that is unrelated to a production plant, office depreciation, and indirect labor. The interest a business pays on its loan would additionally be considered a period cost. 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.

The key difference is product costs can be traced to specific units produced, while period costs cannot. Finally, managing product and period costs will help you establish more accurate pricing levels for your products. The cost of production is an essential component of basic business accounting.

Temporary Accounts vs Permanent Accounts: Which is Not a Temporary Account in Accounting?

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. 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. Allocable but nontraceable costs to products and services—like our electricity example above—are called manufacturing overhead (MOH). We still include MOH as part of product costs even if we can’t trace them directly.