Definition
Period costs are operating expenses that a company incurs that are not directly tied to a specific product’s production or sale. These costs are typically expensed in the period they occur rather than being tied to inventory. Examples can include office rent, advertising expenses, or the salaries of non-production employees.
Key Takeaways
- Period Costs are not directly tied to the production process. They are related to time-based expenditures like rent, utilities and salaries, which are incurred no matter how many units a company produces.
- These costs are typically categorized as Selling, General and Administrative (SG&A) expenses. They are reported as expenses in the period they are incurred, providing understanding of the company’s operational efficiency.
- Unlike product costs that can be capitalized and recognized as expenses as the products they’re associated with are sold, period costs are always expensed in the period they’re incurred, regardless of the amount of production or sales volume. Hence, they are not included in the calculation of the product cost or inventory.
Importance
Period Costs are important in finance because they aid in financial planning, management decisions, and profitability assessment.
They are operational expenses that are not directly tied to production activities, including administrative, selling and marketing costs.
Unlike product costs which are tied to inventory, Period Costs are immediately recognized as expenses in the period they are incurred.
Since they don’t become part of the cost of goods sold, their immediate impact on profit can be assessed.
Therefore, understanding Period Costs is essential for management to make strategic decisions regarding budgeting, forecasting, pricing, and cost control to ensure the company’s profitability and financial health.
Explanation
Period costs play a critical role in financial accounting and management, primarily related to the measurement and evaluation of a company’s performance during a specific period. Quite often, for managing operational expenses, businesses use period costs to monitor their non-production costs and expenses like marketing, sales, administration, and rent for a particular period.
These costs are not directly linked to the product manufacturing sphere, which is why they are not capitalized or involved in inventory calculation but are expensed in the period they incur. Implementing the concept of period costs provides a transparent picture of the costs that are immediately affecting a company’s profitability.
This way, it helps manage and control the overhead costs and facilitate more informed fiscal decisions. Period costs are important for cost accounting as they help in evaluating business efficiency, enabling comparisons between different time periods or different business units.
By identifying and comparing these non-manufacturing costs, managers can also strategize to perform cost-cutting in non-essential areas without compromising the production quality.
Examples of Period Costs
Advertising Expenses: If a company spends money on an ad campaign to sell its products, this cost is considered a period cost. The advertisement does not directly contribute to the manufacturing or production of the products being sold but rather seeks to manage and expand the company’s sales within a specific period.
Rent and Utility Expenses: The cost of renting an office space or spending on water and electricity are also period costs. These costs don’t have much to do with the direct production of goods or services but are necessary expenditures to keep a business running smoothly during a specific period. They are typically expensed in the period they occur.
Employee Salaries: Payment of wages and salaries of non-manufacturing personnel, such as the accounting department, customer service, and executive leadership is a typical period cost. These costs are not associated directly with the manufacturing process but are crucial to the organisation’s function and are expensed during the period incurred.
FAQs on Period Costs
What are period costs?
Period costs are all the costs not included in product costs. These are expenses that are directly tied to an accounting period and are shown in the income statement as expenses in the period they were incurred. This includes such costs as selling, general and administrative expenses.
What is the difference between period costs and product costs?
Product costs are tied up to the production of products and include direct labor, direct materials, and manufacturing overhead. On the other hand, period costs are not directly tied to the production process. These are expenses that are incurred no matter what is produced or sold.
How are period costs recorded?
Period costs are recorded as expenses in the income statement in the period they occur. They are not initially reported as inventory on the balance sheet like product costs. Once a period cost has been paid, it is automatically marked as an expense.
Can period costs become product costs?
No, period costs cannot become product costs. They are distinctly apart. Period costs such as selling, administrative, or any non-manufacturing costs are always treated as expenses in the period they are paid and cannot be linked to the products being made.
Related Entrepreneurship Terms
- Indirect Costs
- Fixed Costs
- Selling and Administrative Expenses
- Operating Expenses
- Depreciations
Sources for More Information
- Investopedia – An expansive financial resource for both students and professionals in the finance industry. The site offers a vast wealth of definitions, articles, and tutorials on a range of financial topics, including period costs.
- Accounting Tools – A site dedicated to providing clear, precise accounting knowledge and training material. It covers many topics related to finance and accounting, offering articles about period costs as well.
- My Accounting Course – This site provides a robust learning platform for accounting students and professionals. It broad covers many finance and accounting concepts, including period costs.
- Corporate Finance Institute – A professional training organization for financial analysts offering courses, certificates, and resources on a wide array of finance topics, including period costs and related concepts.
