Product vs Period Costs Accounting for Managers

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Mohammad Sufyan
in Bookkeeping
June 11, 2020
6 min read

In order to properly calculate profit for a period of time, expenses must be allocated in the right time period. When it comes to cost of doing business, companies need to know both period and product costs. They have to be able to collect enough revenue to cover both, or they will eventually run out of money.

  1. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
  2. But, such a definition can be misconstrued given that some expenditures (like the cost of acquiring land and buildings) will be of benefit for many years.
  3. Customer research may be the most important step in building and maintaining any product.
  4. Some cost-saving measures, like hiring junior developers, may result in several issues later on in the development process.
  5. Instead, you depreciate them over their useful life, expensing a portion of your purchase each year.

The difference between what you spent to buy the inventory and what you sold it for is the profit. A soft drink manufacturer might spend very little on producing the product, but a lot on selling. Conversely, a steel mill may have high inventory costs, but low selling expenses.

Exercise on period and product costs

They determine whether to make more or less of a product, hire or layoff staff, raise or lower prices, and they use financial statements to determine if they should invest in a company. For this reason, it’s very important that financial statements provide an accurate representation of the assets, liabilities, income, and expenses of a business. 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.

Period Costs vs. Product Costs: An Overview

This means that accountants now have to make sure that expenses are recorded in the right time period. The best way to calculate total period costs is to use your income statement as a checklist. Print out your income statement from your accounting software and add a small column to the right. Ask yourself whether each cost incurred is a period cost, and place a checkmark next to each one. Thus, we can conclude that product costs are the opposite of period costs. Product costs can be directly tied to the manufacturing process of inventories.

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. In some cases, it will be too expensive for a company to eliminate certain types of period costs from its operations.

Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities. 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 include any cost of acquiring or producing a product. If you manufacture a product, these costs would include direct materials and labor along with manufacturing overhead. Most of the components of a manufactured item will be raw materials that, when received, are recorded as inventory on the balance sheet.

What is a period expense?

Only when they are used to produce and sell goods are they moved to cost of goods sold, which is located on the income statement. 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 https://simple-accounting.org/ 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).

Items that are not period costs are those costs included in prepaid expenses, such as prepaid rent. Also, costs included in inventory, such as direct labor, direct materials, and manufacturing overhead, are not classified as period costs. Finally, costs included in fixed assets, such as purchased assets and capitalized interest, are not considered to be period costs. Period costs include any costs not related to the manufacture or acquisition of your product.

Therefore, your rent expense should be $3,900 for the quarterly statement. That seems pretty easy, and for some expenses, it is just that easy. 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.

Product Versus Period Costs

However, rent expense for the office is since production does not take place in the office. The manufacturing facility manager’s salary is not a period expense since it is considered a manufacturing overhead cost. On the other hand, the administrative assistant’s salary is a period cost since she works in the office and not on the production floor. Finally, both executives’ salaries are period costs since they also do not work on the production floor. There are many costs businesses incur that are not related directly to product manufacturing.

Cost of goods sold refers to the cost of production of goods, so it is a period cost. Those costs would not be accounted for on the income statement until they are sold. If you’re currently in business, you need a good way to manage costs. Fixed assets cannot be expensed all at once when you purchase them. Instead, you depreciate them over their useful life, expensing a portion of your purchase each year.

When the specialist makes a financial statement, he must classify all expenses as product or period costs. These groups of expenses have many differences, as you can see from the table. Period costs are one of the basic costs that companies must indicate in their financial statements. Nowadays, every successful entrepreneur must know how to report period costs. It helps fill out the ledger accurately and plan your budget effectively for manufacturing procedures.

What could be considered a period expense?

There isn’t a specific algorithm or formula for computation period costs. Management accountants must check all records of expenses and determine those items included in the income statement and not directly related to the production of inventories. In the managerial accounting period, costs refer to expenses not linked to the production of goods (directly or indirectly).

They can also include legal fees and loan interest if these amounts are paid in advance. To quickly identify if a cost is a federal filing requirements for nonprofits or product cost, ask the question, “Is the cost directly or indirectly related to the production of products? Calculating product costs can be a difficult task, especially when it comes to determining the development costs of SaaS. However, there are some basic formulas to help calculate the product cost. Take rent payments as an example.Your monthly rent is $1,300, and you’re preparing an income and expense statement for the period of Jan. 1 to March 31.

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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. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.

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