Difference Between Product Costs and Period Costs Examples

Freight would be considered a period cost if it is paid to ship the finished product to customers. This freight cost reflects a selling/distribution expense rather than a production expense. These costs are expensed immediately on the income statement rather than being included in the costs of goods sold. They are incurred whether or not production occurs during the period. Period costs and product costs are two important concepts in managerial accounting that classify costs to analyze financial performance. Most business owners would agree that properly classifying costs as either „period” or „product” expenses is critical for accurate financial reporting and strategic decision making.

Direct materials

Below is a simple flowchart we designed that summarizes how to distinguish period costs vs product costs. 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.

Is freight in a product or period cost?

Learn about emerging trends and how staffing agencies can help you secure top accounting jobs of the future. Our writing and editorial staff are a team period costs vs product costs of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. It means that DM and DL increase as production increases, and they decrease if production decreases as well.

Comparing Product Costs and Period Costs

If the accounting period were instead a year, the period cost would encompass 12 months. The purpose of doing so is a more accurate representation of information. However, in most cases, there is a tradition of transferring period costs to operational costs. Many options in accounting software help you record and keep track of costs involved in business operations. Regardless of the business size, it is essential to understand the different product, operational, and non-operational costs involved in your business to differentiate each one from the other.

Top 5 Differences

• Eighty units have been sold out of the 100 manufactured units, and 20 units are still in the closing inventory at the year-end.
• The product costs measured and recorded in the company’s records are also used to prepare the financial statements.
• Product costs (direct materials, direct labor and overhead) are not expensed until the item is sold when the product costs are recorded as cost of goods sold.
• These items are directly traceable or assignable to the product being manufactured.
• In the accounting records, the cost of finished products is accumulated in an inventory account – usually „Finished Goods Inventory”.
• The cost of 80 units will be transferred to the income statement and will be recorded as the cost of goods sold.
• These costs include the costs of direct materials, direct labor, and manufacturing overhead.

All the periodic costs of a business entity are recorded in the income statement under the head of operational costs. The gross profit is calculated by subtracting the product costs from total revenues generated in a financial period. Product cost comprises of direct materials, direct labour and direct overheads. Period costs are based on time and mainly includes selling and administration costs like salary, rent etc. These two type of costs are significant in cost accounting, that most people don’t understand easily. So, take a read of the article, that sheds light on the differences between product cost and period cost.

• Period costs include any costs not related to the manufacture or acquisition of your product.
• (You may also see other names for manufacturing overhead, such as factory overhead, factory indirect costs, or factory burden).
• Administrative expenses are non-manufacturing costs that include the costs of top administrative functions and various staff departments such as accounting, data processing, and personnel.
• Product costs for a manufacturer will be the direct materials, direct labor, and manufacturing overhead used to manufacture a product.
• Period costs are also an essential part of the cost and managerial accounting in any business entity.
• In summary, proper classification of costs as either product or period expenses is vital for financial reporting accuracy and strategic business management.

To continue our bakery example, let’s say we’re hiring an external bookkeeper to do the books. 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. 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.

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.