Period Cost VS Product CostComparison of Differences along with Examples

The primary purpose of starting and running a business is to earn profits.

However, in the pursuit of such profits, a business will inevitably incur expenses.

For example, if a business manufactures its own products, it will have to spend money to buy the materials it needs for production.

In addition to that, the business will have to pay the people that will convert the materials into sellable goods.

There’s also the cost of maintaining the machinery and equipment that are used in the manufacturing process.

The point is that a business will incur expenses in the process of making profits.

Some of the expenses that a business incurs have nothing to do with the production of goods at all.

But even so, they are necessary and often unavoidable expenses.

There are the salaries and wages of executive officers, office workers, and other employees not involved in the production process.

If the business does not own any building, then it will have to rent space to house its various non-production functions such as administration, accounting, customer service, etc.

There’s also the cost of maintenance and utilities.

Depending on whether an expense is involved in the production process or not, it could be classified either as a product cost or a period cost.

In this article, we will be discussing the differences between the two.

What characteristics does a period cost have?

How about a product cost?

Do all businesses incur these two types of costs or expenses?

Let’s try to answer these questions as we go along with the article.

We’ll also be having exercises to deepen our understanding of period cost and product cost.

What are Product Costs?

A business may spend money to acquire the materials it needs to produce a sellable product.

In addition to that, there’s also the cost of converting such materials into its product offerings.

These costs that are directly involved in the production or acquisition of goods are what we refer to as product costs.

Depending on the type of business, the costs/expenses that are product costs will differ.

For a business that manufactures its own goods, its product costs will typically include the following:

• Raw materials
• Direct labor
• Manufacturing overhead
  • Indirect materials (e.g. glue, lubricants, oil, etc.)
  • Indirect labor (e.g. the salary or wage of the plant manager)
  • Costs incurred in operating the building that houses the manufacturing functions (e.g. utilities expenses, janitorial expenses, etc.)
  • Cost of maintaining the machinery and equipment to ensure that they are in their optimal state
  • Depreciation of fixed assets that are involved in the manufacturing process

For a business that does retail or wholesale, its product costs will include the cost of the supplies it purchased. If the business incurs any other costs to bring its goods to market (e.g. transportation, freight, etc.), then those are product costs too. Basically, any costs that a retailer or wholesaler incurs to acquire the goods that it will sell are product costs.

A business that doesn’t sell goods won’t incur product costs.

Depending on whether the products are sold or unsold at the end of the period, their related product costs will either appear on the balance sheet or income statement.

For unsold products, their costs will appear on the balance sheet as “inventory”.

This is why we sometimes refer to product costs as inventoriable costs.

For sold products, their costs will appear on the income statement as “cost of goods sold”.

What are Period Costs?

A business may incur expenses whether or not it produces goods.

For example, if a business rents space to house its accounting function, then it will incur the cost of rent whether it produces goods or not.

We refer to these costs that are not directly related to the production of goods as period costs.

One reason we refer to them as such is that they are costs that a business typically incurs every period. For example, as long as the business rents space or a building, it will periodically incur rent expenses.

Common examples of period costs include the following:

• Salaries and wages of office staff (e.g. admin staff, hr staff, accounting staff, etc.)
• Cost of renting the space or building that houses the non-production functions (e.g. administrative, accounting, customer service, etc.)
• Selling expenses such as sales commission
• Audit fees
• Legal fees
• Financing expenses (e.g. interest expense)
• General and administrative expenses
• Marketing and advertising expenses
• Travel and entertainment expenses
• Office supplies expense
• Executive and administrative salaries and benefits

Period costs cannot be tied to any particular product.

As such, they are not inventoriable.

They will always appear in the income statement during the period in which the business incurs them.

All businesses, whether they acquire/produce goods or not, will incur period expenses for as long as they operate.

Period costs include both operating and non-operating expenses.

Period Costs VS Product Costs

Now that we’ve discussed period costs and product costs, it’s time to identify the differences between them.

To start, only businesses that produce or acquire and eventually sell goods incur product costs.

Businesses that don’t sell goods will not incur product costs.

On the other hand, a business will always incur period costs whether or not it produces and sells goods.

This is because period costs are expenses that are not tied to the production process.

Product costs may appear on the balance sheet or income statement depending on whether their related goods are sold or unsold at the end of the period.

For unsold goods, their product costs appear on the balance sheet as “inventory” which is an asset account.

For sold goods, their product costs will appear on the income statement as “cost of goods sold” which is an expense account.

On the other hand, period costs will always appear on the income statement. They don’t naturally appear on the balance sheet as they are expense accounts.

Product costs only include the operating cost of the business (cost of goods sold).

On the other hand, period costs may include both operating and non-operating expenses (such as interest expenses).

Examples of operating expenses include salaries and wages of office staff, office supplies expenses, etc.

Both period costs and product costs can be variable or fixed (or even mixed).

Product costs are usually variable as they depend on the production process of the business.

The higher the volume of production, the higher the product costs will be.

There are still some product costs that don’t rise or fall with the level of production such as the cost of renting the building that houses the production process.

Period costs are usually fixed but they can sometimes be variable.

Period Cost VS Product Cost: Exercise

Identify whether the following expenses are period costs or product costs:

1. Salaries and wages of office staff
2. Transportation cost of bringing goods to market
3. Salary of the plant manager
4. Cost of renting the building that houses the accounting function
5. Direct labor
6. Raw materials
7. Cost of supplies that office staff use
8. Cost of supplies used in the production process
9. Salary of the plant supervisor
10. Salary of the general manager

Answers: 1. period cost, 2. product cost, 3. product cost, 4. period cost, 5. product cost, 6. product cost, 7. period cost, 8. product cost, 9. product cost, 10. period cost