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Period costs, also known as non-manufacturing costs or period expense, include all non-manufacturing overhead costs such as marketing and selling costs and general administrative costs incurred by passage of time rather than by production. Such costs do not directly relate to production and do not trace back to the products or inventory in the same way that product costs such as materials, labor and manufacturing related overheads do.
Image Credit: geograph.org.uk/Alexander P Kapp
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Period Cost Identification
A good indicator of the type of cost is the stage at which the cost incurs. Product costs usually occur during the manufacturing stage, and period costs usually occur either after the manufacturing stage or outside the factory. Some capital assets such as buildings and equipment as well as some intangible costs occurring outside the factory and not connected to the manufacturing process, however, do find amortization as product costs.
Common types of period costs in manufacturing enterprises include:
- Costs incurred for selling the products, such as cost for advertising, cost of establishing and maintaining the distribution system, and other marketing costs.
- General and administrative costs such as rent of the corporate office, salary of the CEO, human resources, finance, and other administrative staff, cost of maintaining corporate utilities, and employee benefits such as health clubs, corporate depreciation and other costs.
- Research and development costs including product development costs.
- Capital loan repayment and interest outflow.
- Insurance premium payout.
Period costs in merchandising companies or retail stores include all overheads or costs other than the cost price of products. Service sector companies usually do not have a distinction between product costs and period costs, and for them, all costs are period costs.
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Treatment in Accounting
Period costs usually remain fixed irrespective of the inventory or production volume, and the treatment of period costs in accounting statements is listing such costs as expenses and charging it against sales revenue during the accounting period under which such costs incur.
Traditional cost accounting systems such as absorption costing determine product pricing by dividing the period costs equally or arbitrarily with the number of units produced during the same period. Modern cost accounting methods such as activity-based costing (ABC), however, try to assign period costs to activities, and in turn assign the costs of activities based on the proportion of usage by individual product units.
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Period costs or overhead add to the burden of the company by increasing prices and reducing profits. In a highly competitive business environment, the direct costs such as raw materials and labor remain more or less constant, as do profit margins. Companies try to boost profitability by trying to eliminate period costs. Most companies consider the value added to the product by each non-manufacturing activity or period cost and retain or eliminate such activity based on either the indispensability or the value addition of the activity.
For instance, some period costs such as the costs of financial audits to maintain an effluent treatment plant, even though not adding value to the product, remain indispensable owing to statutory requirements. Other period costs such as investments in green technology or initiatives such as total quality management add value to the product directly, and still other period costs such as career development activities for the employees and the like do not directly contribute to the product value but provide indirect benefits.
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University of Illinois at Chicago. Manufacturing Costs [PDF]. http://www.unf.edu/~dtanner/dtch/dt_ch29.pdf