Table of Contents Hide
- What are Period Costs?
- Definition of Period Cost
- Period Costs and How They Work
- Different Types of Period Costs
- Examples of Costs during a typical period
- Product Costs vs. Period Costs
- Examples of Period Costs
- Period costs: How to Calculate and Report Them
- Period Cost Reporting
- The Importance of Period Costs
- Benefits of Period Costs
It is critical to understand how to report period costs in order to properly balance your accounts and maximize your budget for operations. This article will offer you a guide that defines period costs, describes their different types, the examples discusses their importance, and walks you through the procedures you can take to report period costs.
What are Period Costs?
Period costs are the costs incurred by a corporation to create items or deliver services that cannot be capitalized into prepaid expenses, inventories, or fixed assets.
In other words, period costs are expenses that are not directly related to a company’s production process, but rather are incurred over time.
Sales, general, and administrative charges, for example, are an excellent illustration of a period cost because they are charges that are not related to the manufacture of a specific product and are incurred over time.
In general, when a company manufactures a product, it incurs two types of costs:
- Period costs
- Product costs
Product costs are the costs incurred by a business that is directly tied to the manufacturing of goods.
Because product costs are associated with a specific product, a corporation can report such costs on the income statement under the category of cost of goods sold.
However, because product costs such as office expenses, administration expenses, marketing expenses, rent, and so on cannot be connected to the cost of goods sold, they are charged to the expense account.
Definition of Period Cost
Period costs are defined as follows by the Corporate Finance Institute:
Costs that cannot be capitalized on a company’s balance sheet are referred to as period costs. In other words, they are expensed in the period in which they occur and are recorded on the income statement. Period costs are sometimes referred to as period expenses.
Period costs are, as you can see from this financial definition, as follows:
- Non-capitalized costs on the balance sheet
- Incurred throughout a period
- Costs shown on the income statement
Period Costs and How They Work
Period costs are essentially charges that could be applied to the company’s income statement for the period in which such expenses were incurred. These expenses are not directly tied to inventory production and so do not constitute part of the cost of goods sold and are charged in the company’s income statement. Because these costs do not relate to the manufacturing of inventory, they can never be capitalized and must always be included in the company’s income statement. Selling costs, overhead costs, advertising costs, and so on are examples of these costs.
Different Types of Period Costs
The following are three types of period expenses:
- Current expense: Expenses incurred by the company during the current period.
- Historical expense: Expenses incurred in the preceding period that should not be considered in decision making.
- Pre-determined expenses: Expenses that businesses forecast for a future period and compute in order to establish a budget, which should be taken into account when making decisions.
Examples of Costs during a typical period
Here are some examples of frequent types of period costs encountered by businesses:
- Legal and professional fees: Fees paid to lawyers, accountants, and other consultants by businesses.
- Office Expenses: Supplies, rent, and other office-related expenses are examples of office expenses.
- Utilities include water, electricity, gas, and other services.
- Marketing expenses such as commercials, social media ads, and other promotional goods are examples of advertising and promotion.
- Maintenance and repairs include the upkeep of the office as well as expenses for damages to any equipment that has to be repaired.
- Expenses incurred during business visits for travel, meals, and entertainment
- Salaries: The money that firms pay their employees in exchange for their services.
- Employee benefits include expenses such as retirement funds, health insurance, and other perks.
- Insurance: Insurance costs are typically incurred by businesses in order to protect their assets.
- Interest on loans and other liabilities: Many firms are required to pay interest on loans on a monthly basis.
- Automobile expense: Any corporate automobiles that are not directly tied to product manufacturing or distribution.
Product Costs vs. Period Costs
A company’s costs are classified as either period costs or product costs. Furthermore, the two types of costs are reported in distinct ways. For a more detailed comparison, see the table below:
|Product Costs||Period Costs|
|Definition:||Costs related to the production of a product||Costs not related to the production of a product|
|Method of Recording:||Capitalized on the balance sheet as inventory and eventually expensed to cost of goods sold on the income statement||Expensed on the income statement in the period incurred|
|Examples:||Direct labor, direct materials, and manufacturing overhead||Marketing expense, selling, general and administrative expense, and CEO salary|
To rapidly determine whether a cost is a period cost or a product cost, ask yourself, “Is the expense directly or indirectly tied to the manufacturing of products?” If the response is no, the cost is a one-period cost.
Examples of Period Costs
#1. Fixed Price
Fixed costs are costs that remain constant throughout a specific period of time, regardless of output level. In general, fixed costs include fixed production overhead and administrative overhead. The fixed cost per unit of production will fluctuate inversely with output level variations. Fixed costs fall as output rises and vice versa. Fixed costs are charged to the Profit and Loss Account as time costs.
It will continue to accrue, and an entity will be required to endure the same without profit or revenue. Rent, wages, insurance, and other fixed costs are examples.
#2. Inventory Valuation Using Period Expense
The first-in-first-out (FIFO) approach
Weighted-average costing combines current-period expenses with prior-period costs in the beginning inventory. Managers are unable to determine the current period expense of manufacturing the product as a result of this combination. This issue is addressed by first-in, first-out (FIFO) costing, which assumes that the first units worked on are the first units moved out of a production department.
FIFO distinguishes between current-period expenses and those in beginning inventory. The costs in the initial inventory are moved out in a lump sum under FIFO costing. FIFO costing does not combine former tenure costs (in beginning inventory) with current period expenses.
#3. Capacity Price
Capacity costs or supportive overheads are resources consumed to provide or sustain the organization’s capacity to produce or sell. Standby costs and enabling costs are subdivided into capacity costs. If the company temporarily shuts down activities or facilities, standby costs will remain. Depreciation is one example.
If operations are halted, the firm will not incur enabling costs; nevertheless, if operations are resumed, the firm will incur them. Some will most likely be consistent across the whole output range, while others will likely fluctuate in steps. A single-shift operation, for example, may only require one departmental supervisor, whereas a second shift operation will necessitate the hiring of a second supervisor.
Period costs: How to Calculate and Report Them
Businesses and accountants do not utilize a standardized approach or formula to compute period costs. Management accountants must frequently scrutinize a company’s expenses to determine which are period costs and which are production costs before adding them to the income statement. Once they’re on the income statement, the accountant can deduct them from the gross profit to calculate the period’s net income.
The following are some measures you can take to report the period cost for your company:
#1. Maintain a record of your period costs.
Make a note of how much money you spend on period costs and expense them during the period in which the costs are incurred. Receipts, employee pay stubs, invoices, and other papers that show how much money you pay out for various period costs may be kept.
#2. Incorporate your period costs into your income statement.
When period costs are expensed, they appear on your income statement and diminish your net income. To acquire a better idea of your costs and how much you spend on each, you may choose to segregate period costs by category on your income statement. This assists you in determining your expenses and provides an accurate estimate of your net income. Your income statement will also include your cost of products sold, taxes, and total revenue for the fiscal period.
#3. Every year, reassess your period costs.
Many period costs are variable. When creating your budget each year, you might cut costs by reevaluating your period expenses. For example, if you alter insurance premiums or even switch to a firm with lower premiums, the price difference must be reported. Reassessing your period costs may assist you in identifying areas where you can save money.
Period Cost Reporting
Time costs are stated in accordance with
- They generate revenue as a result of their expenses.
- Tenure expired and had to be charged to the profit and loss account.
- Accrual for a given fiscal period.
Financial Statement Disclosure
Period expenses appear on the income statement with a caption that corresponds to the item in the period in which the cost is spent or recognized.
All period expenses are useless for decision making. However, under the following rare instances, it must be considered for decision-making:
- When they are incurred specifically for a contract;
- When they are progressive;
- that they are avoidable or voluntary
- It is incurred in place of another
The Importance of Period Costs
The period cost is extremely important in the operation of a corporation. The following are some examples of the importance of period costs:
- Period costs are not directly tied to inventory production but are critical to the operation of the firm. Period costs encompass all other indirect charges that play an important part in the business’s financial success.
- The evaluation of period costs assists the company’s management in effective planning since period costs play an important role in analyzing a company’s or organization’s financials. Period costs are immediately charged in a company’s profit and loss account and so play a key role in calculating the company’s profit or loss.
- The evaluation of period costs assists management in keeping track of the fixed costs that must be incurred that are not very dynamic in nature.
Benefits of Period Costs
The study and evaluation of period costs benefits the company’s management in the following ways:
- Because the primary goal of any entity is to produce and sell its products or services, period costs assist the entity in managing all other activities expenses that may not directly relate to the production of goods but are critical to the company’s operation of making a profit through the business.
- In general, period cost is less volatile or dynamic. The analysis of period expenses that are continuously rising or reporting increments in upcoming periods enables management to take appropriate actions and steps to identify the need & reason for such increments and aids in reducing the same, allowing the company’s financials to yield a higher profit.
- The management and analysis of period costs assists the management and operations team in reducing the cost incurred in the period expenses and deducing the best means of implying the cost and giving the best outcome or result.
The entity’s period cost is just as important as its product cost. The period costs could not be capitalized since they are not directly tied to the manufacture of inventory and are thus charged in the company’s profit and loss statement. Better management of period costs assists the business in identifying expenses and areas of expenses where the same or better services and results might be obtained with less expenditure to the organization. The management of period costs assists the corporation in better planning and enables the organization to use the greater earnings in expanding the business, allowing the entity to earn more profit.