Therefore, period costs are listed as an expense in the accounting period in which they occurred. The expenses that are compiled for the calculation of Period costs are not related Other expenses will not be considered as a period cost because they are directly related to the process of production of inventory. 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. Period costs are costs that are not incurred in the manufacturing of a product. The formula for period costs is simply adding up all costs that are classified as period costs.
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. Executive salaries, clerical salaries, office expenses, office rent, donations, research and development costs, and legal costs are administrative costs. Direct labor costs include the labor costs of all employees actually working on materials to convert them into finished goods. As with direct material costs, direct labor costs of a product include only those labor costs distinctly traceable to, or readily identifiable with, the finished product.
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. They are the costs that are directly and indirectly related to producing an item. The most common product costs are direct materials, direct labor, and manufacturing overhead. Selling expenses are costs incurred to obtain customer orders and get the finished product in the customers’ possession.
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. There is no specific method or formula for calculation of period costs. This way the management could identify the expenses that could be classified as period costs and it will become easy to evaluate and compare the same figure with the figure in the previous years. Period costs are basically the expenses which could be charged to income statement of the company for the period in which such expenses have been incurred.
Period Cost Examples
Period costs are calculated by identifying costs classified as period costs. The main benefit of classifying costs as either product or period is that it helps managers understand where their costs are being incurred and how those costs relate to the production process. This information can be used to make decisions about where to allocate resources and how to improve efficiency. Direct materials are those materials used only in making the product and there is a clear, easily traceable connection between the material and the product.
- In short, all costs that are not involved in the production of a product (product costs) are period costs.
- Product costs also include Depreciation on plant, expired insurance on plant, production supervisor salaries, manufacturing supplies used, and plant maintenance.
- A product cost is incurred during the manufacture of a product, while a period cost is usually incurred over a period of time, irrespective of any manufacturing activity.
- Rent can be a period cost or a product cost depending on what the rented building is used for.
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However, these costs are still paid every period, and so are booked as period costs. 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? The preceding list of period costs should make it clear that most of the administrative costs of a business can be considered period costs. Rent can be a period cost or a product cost depending on what the rented building is used for. If the rented building is used as a manufacturing facility, it is a product cost.
Examples of period costs include selling and administrative expenses. Both of these types of expenses are considered period costs because they are related to the services consumed over the period in question. Product costs are all the costs that are related to producing a good or service. These items are directly traceable or assignable to the product being manufactured.
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.
Items That are Not Period Costs
These fringe benefit costs can significantly increase the direct labor hourly wage rate. Other companies include fringe benefit costs in overhead if they can be traced to the product only with great difficulty and effort. 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. 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.
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. Remember, when expenses incurred may not be when cash changes hands. If advertising happens in June, you will receive an invoice, and record the expense in June, even if you have terms that allow you to actually pay the expense in July. The cash may actually be spent on an item that will be incurred later, like insurance.
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These costs are identified as being either direct materials, direct labor, or factory overheads, and they are traceable or assignable to products. To illustrate, assume a company pays its sales manager a fixed salary. When preparing financial statements, companies need to classify costs as either product costs or period costs.
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. The period costs could not be capitalized as they are not directly related to the production of the inventory and hence are charged in the profit and loss statement of the company. The management of the period cost helps the company to prepare better budgeting and able the entity to use the increased profit in expanding the business through which the entity will yield more profit. 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.
Period Costs vs. Product Costs: An Overview
Selling expenses are incurred to market products and deliver them to customers. Administrative expenses are required to provide support services not directly related to manufacturing or selling activities. Administrative costs may include expenditures for a company’s accounting department, human resources department, and the president’s office. Selling and administrative expenses may also include utilities, insurance, property taxes, depreciation, supplies, maintenance, salaries, etc. that are incurred in a business but outside of the factory production area.
These expenses are not directly related to the production of inventory and thus does not form part of the cost of goods sold and are charged in the income statement of the company. These costs does not constitute to production of inventory and hence these costs can never be capitalized and always form part of the income statement of the company. Examples of these costs are Selling cost, overhead costs, advertisement costs etc.
Example of Period Costs
In general, overhead refers to all costs of making the product or providing the service except those classified as direct materials or direct labor. Manufacturing overhead costs are manufacturing costs that must be incurred but that cannot or will not be traced directly to specific units produced. In addition to indirect materials and indirect labor, manufacturing overhead includes depreciation and maintenance on machines and factory utility costs. 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.
The wages paid to a construction worker, a pizza delivery driver, and an assembler in an electronics company are examples of direct labor. Both of these costs are considered period costs because selling and administrative expenses are used up over the same period in which they originate. Firms account for some labor costs (for example, wages of materials handlers, custodial workers, and supervisors) as indirect labor because the expense of tracing these costs to products would be too great. Indirect labor consists of the cost of labor that cannot, or will not for practical reasons, be traced to the products being manufactured.
Accountants treat all selling and administrative expenses as period costs for external financial reporting. The company has one very large manufacturing facility but has a few dealerships and offices around the country. The company manufactured and sold 1,000 cars during the fourth quarter.