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.
Product costs are the direct costs involved in producing a product. A manufacturer, for example, would have product costs that include:
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 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. 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.
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.
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.
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.
A direct cost is a price that can be directly tied to the production of specific goods or services. A direct cost can be traced to the cost object, which can be a service, product, or department. Direct and indirect costs are the two major types of expenses or costs that companies can incur. Direct costs are often variable costs, meaning they fluctuate with production levels such as inventory. However, some costs, such as indirect costs are more difficult to assign to a specific product. Examples of indirect costs include depreciation and administrative expenses. Although direct costs are typically variable costs, they can also include fixed costs. Rent for a factory, for example, could be tied directly to the production facility. Typically, rent would be considered overhead. However, companies can sometimes tie fixed costs to the units produced in a particular facility. Any cost that's involved in producing a good, even if it's only a portion of the cost that's allocated to the production facility, are included as direct costs. Some examples of direct costs are listed below:
Because direct costs can be specifically traced to a product, direct costs do not need to be allocated to a product, department, or other cost objects. Direct costs usually benefit only one cost object. Items that are not direct costs are pooled and allocated based on cost drivers.
Direct and indirect costs are the major costs involved in the production of a good or service. While direct costs are easily traced to a product, indirect costs are not.
Direct costs are fairly straightforward in determining their cost object. For example, Ford Motor Company (F) manufactures automobiles and trucks. The steel and bolts needed for the production of a car or truck would be classified as direct costs. However, an indirect cost would be the electricity for the manufacturing plant. Although the electricity expense can be tied to the facility, it can't be directly tied to a specific unit and is, therefore, classified as indirect. Direct costs do not need to be fixed in nature, as their unit cost may change over time or depending on the quantity being utilized. An example is the salary of a supervisor that worked on a single project. This cost may be directly attributed to the project and relates to a fixed dollar amount. Materials that were used to build the product, such as wood or gasoline, might be directly traced but do not contain a fixed dollar amount. This is because the quantity of the supervisor's salary is known, while the unit production levels are variable based upon sales. Using direct costs requires strict management of inventory valuation when inventory is purchased at different dollar amounts. For example, the cost of an essential component of an item being manufactured may change over time. As the item is being manufactured, the component piece's price must be directly traced to the item. For example, in the construction of a building, a company may have purchased a window for $500 and another window for $600. If only one window is to be installed on the building and the other is to remain in inventory, consistent application of accounting valuation must occur. Companies typically trace these costs using two methods: first-in, first-out (FIFO) or last-in, first-out (LIFO). FIFO involves the assigning of costs, such as the purchase of inventory, based on what items arrived first. As inventory is used up in the production of goods, the first ones or the oldest inventory items are used first when measuring the cost of the item. Conversely, LIFO assigns the value of a cost item based on the last item purchased or added to inventory. |
The direct cost incurred in using an asset for the purpose for which it was intended is termed as
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