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In financial accounting, costs usually appear as account balances on the balance sheet or as expenses in the income statement. Companies classify these costs based on accounting conventions and standards. However, the same does not apply to managerial accounting. In that branch, companies may divide costs based on other factors. One such classification occurs between period and product costs.
Period and product costs are different in various ways. Before discussing the differences between these costs, it is crucial to study both individually.
What are Product Costs?
Products costs refer to costs the companies incur on acquiring or producing a product. These costs are relevant for companies that sell goods. Usually, product costs include raw material and conversion costs. Conversion costs, in turn, include direct labour and factory overheads. Usually, companies capitalize product costs as a part of the inventory or stock balances.
Product costs are crucial in managerial accounting to establish the cost of producing a single product unit. These become a part of the finished goods on the balance sheet. Once the company sells the underlying products, it can transfer those costs to the income statement for that period. Product costs are variable and fluctuate as the activity levels within a company increase or decrease.
What are Period Costs?
Period costs include all costs incurred during a specific time. These are items not related to the production or acquisition process directly. Therefore, period costs consist of all items not included as product costs. These costs do not become a part of the capitalized cost of a specific product. Instead, companies expense out period costs each period through the income statement.
Period costs include several overheads that do not contribute to the production process. These may be rent, selling costs, depreciation, interest, etc. Unlike product costs, these costs do not go to the balance sheet. Period costs are still crucial to running a company. However, these costs generally relate to the administrative side of the business.
Product Costs vs Period Costs: What are the differences?
The differences between product and period costs can be summarized in the following areas.
Companies apportion product costs to every unit of the product acquired or produced. This process selects only those costs directly related to that unit. On the other hand, period costs do not get apportioned or assigned to any unit of product. Instead, companies charged them to the income statement as an expense.
Product costs increase as the activity levels within a company grow. On the other hand, period costs do not relate to how many units a company produces. Instead, these costs fluctuate with time.
Product costs usually include material costs, labour costs, and factory overheads. On the other hand, period costs include administrative, selling, offices, and similar expenses.
Impact on financial statements
As mentioned above, product costs become a part of the balance sheet through finished goods. When companies sell those goods, these costs go to the income statement. On the other hand, period costs do not impact the balance sheet. These become an expense on the income statement for each period.
Companies incur costs during their business. They may need to classify these costs for several reasons. Usually, companies seek to differentiate between product and period costs. Product costs include any items directly related to acquiring or manufacturing products. Period costs are an expense for a specific period.
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