Uhg! Product Costs versus Period Costs! What’s Next?
Okay, so accounting has a lot of terms, many of which overlap. Seriously though, product costs and period costs are among the easiest terms to learn, so read on. These terms are most often associated with the manufacturing industry. Think of them like little boxes used to categorize expenses. Imagine two open boxes and a list of expenses. Your mission, should you choose to accept it (as the popular saying goes), is to decide which box each expense goes into. Let’s label the boxes. We’ll call one box period costs and one box product costs. The battle is on! How do you figure out which box each expense goes into?
Oh, the good old cost of the products we produce. Wait, is that a definition? Let’s see. Product costs are those expenses associated with making a product. They include expenses such as direct labor, raw materials, and manufacturing overhead. Well, all that is great, but nothing beats some good old-fashioned examples. So let’s give some:
- Henry works on the production assembling widgets – product cost.
- Glue is used in places to hold widget parts together – manufacturing overhead and product cost.
- Nails used on the widget – product cost.
- Paint used to make the widget look pretty – product cost.
- Sally is Henry’s supervisor. She causes Henry unending amounts of stress by carefully scrutinizing his widgets – product cost. (Sally is still in the warehouse working directly with the product. She could also fall under the manufacturing overhead category).
Product costs are often recorded in the inventory account with the merchandise. When the merchandise is sold, product costs are then recorded as an expense, often referred to as cost of goods sold. Now, wasn’t that easy? So with an understanding of product costs under our belt, it’s now time to tackle period costs. Let’s get to it.
If product costs are those costs directly associated with the manufacturing of a product, then what are period costs? Well, quite simply, everything else. That’s right: If it is not a product cost, it is a period cost. These costs include selling and administrative expenses, rental expenses, executive salaries (that’s right, you’re good old friendly neighborhood accountant falls under period costs), advertising, marketing and most utilities. Unlike product costs, which are not expensed until the item is sold, period costs are expensed as they are incurred. Period costs follow the traditional accrual method in this way.
If rent is due on January first, then the period cost of rent is recorded as an expense on January first. That is not to say that cash actually changed hands, however. Sometimes an expense is coded to accounts payable to show that it is due but has not yet been paid. When the expense is paid, the amount shown as due in the accounts payable account goes down and the amount of money in the bank account goes down.
And that, friend, is the story of product costs versus period costs. Go forth and use the knowledge wisely!
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