A cost refers to expenses incurred for a specific purpose. For companies, this purpose includes producing and selling their products and services. Incurring costs are crucial in helping companies make revenues. Usually, these costs come from various sources and accumulate into a single unit. This unit may differ from one company to another. In most cases, however, it includes a single product or service.
In managerial accounting, costs are also crucial in helping companies ensure profitability. Managerial accounting refers to the branch of accounting which covers the quality of information. It covers the flow of financial data within a company. Similarly, managerial accounting provides useful financial information to managers for better decision-making. One of the areas within this branch includes cost accounting, which primarily focuses on costing techniques.
Companies may divide their costs based on various criteria. Cost classification is common within managerial accounting to help produce better reports. On top of that, it also enhances the quality of decisions made by a company. Companies may classify their costs in various ways. For example, they may include division by element, nature, function or behaviour.
One such classification involves differentiating between period and product costs. Period costs are highly crucial in financial accounting as well. However, product costs can also be as critical.
What are Period Costs in Managerial Accounting?
Period cost is any cost that companies cannot capitalize into prepaid expenses, inventory or fixed assets. In other words, these costs relate to any item that doesn’t classify as product costs. A period cost correlates more closely with time than with a transactional event. Period costs usually include fixed costs and relate to items not associated with production or services.
Period costs do not go on the balance sheet as a capitalized amount. In other words, they become a part of the income statement and do not fall under the former statement. Period costs, also known as period expenses, are expenses for a specific duration. Companies charge it in the income statement for that duration. For example, period costs associated with 202X will become a part of that income statement.
Period costs do not become a part of the cost of goods sold in the income statement. Instead, it is usually a part of the other headings in that statement. It falls under operating or selling and administrative expenses. Essentially, if a cost is consumed or put in a specific accounting period, it is a period cost. If it relates to a product or multiple periods, it is a product cost.
Another definition of period costs includes any expenses that are not a part of product costs. Primarily, product costs are the direct costs involved in manufacturing a product. For services, it includes expenses in rendering a service. Usually, these costs include direct labor, raw material, factory overheads, etc. Period costs do not consist of any of these items. It is essential to understand what product costs are before identifying period costs.
Period costs in managerial accounting cover the same definitions. Identifying product costs and differentiating them from period costs is crucial. For costing techniques, such as marginal and absorption costing, both these costs are critical. In most cases, period costs include SG&A (sales, general and administrative) costs. It involves the expenses relating to marketing and selling with the administration costs.
What are the types of Period Costs?
Period costs are a classification of expenses based on the timing. Similarly, they may include any costs not associated with a product. For companies, these costs become a part of the income statement. Product costs, in contrast, are items that fall under the balance sheet. This process occurs through the capitalization of expenses for specific assets.
Companies may further classify period costs into three types. These include current, historical, and pre-determined expenses. Primarily, these classifications occur through the time to which costs relate. An explanation of each of these types is below.
Current period costs
Current period costs relate to the current period in which a company is operating. These expenses occur at the same time as the company’s current operations. Usually, current expenses do not exceed the current period. Similarly, they do not come from historical transactions. Current period costs also don’t cover any future or forecasted expenses.
Historical period costs
Historical period costs include expenses already incurred in a previous period. In managerial accounting, these may be irrelevant to the decisions made by companies. Sunk costs may also fall under historical period costs. For companies, any costs associated with the current period don’t constitute historical period costs. Similarly, forecasted or future expenses do not fall under this category.
Pre-determined period costs
Pre-determined period costs include expenses that companies estimate for a future period. Usually, these period costs are a part of the budgets prepared by companies. Similarly, they can contribute to any forecasts for future periods. For most companies, these costs are relevant when making capital budgeting decisions. Pre-determined period costs don’t include historical and current period costs.
What is the difference between Period and Product Costs?
As mentioned above, period costs and product costs are two classifications for expenses. The definition for the former includes any items that are not a part of the latter. Therefore, it implies that these costs are significantly different from each other. Some of the differences between period and product costs include the following.
|Period Costs||Product Costs|
|Covers indirect costs and overheads||Covers volume-related costs, e.g., material, labor, etc.|
|Does not relate to activity levels||Depending on the manufacturing process|
|Fall under the income statement||Capitalized in the balance sheet|
|Usually fixed, although may cover semi-fixed costs also||Always variable and depend on activity levels|
The above points cover most differences between period and product costs. However, these costs may differ based on companies and how they treat their expenses. On top of that, accounting standards may dictate how companies treat them. In managerial accounting, the classification of expenses under each head may be more straightforward.
Examples of Period Costs in Managerial Accounting
The examples of period costs may differ from one company to another. On top of that, it may vary based on a company’s cost classification. There are several examples of period costs in managerial accounting in practical scenarios. Some of those include the following.
One of the most prevalent examples of period costs includes fixed costs. These constitute any expenses that remain constant for a given period. Usually, fixed costs consist of fixed production overheads and administrative expenses. Although the per-unit cost may vary for these costs, the total expense remains the same. Companies charge these costs in the income statement for each period. Usually, they include rent, salaries, etc.
As mentioned above, one of the definitions of period costs includes any expenses that don’t fall under product costs. Usually, these consist of all items in the income statement that aren’t a part of the cost of goods sold. For example, depreciation, interest expenses, freight charges, etc., fall under period costs. Since these costs don’t become a part of product costs, they form period costs instead.
Cost classification is an essential part of managerial accounting and can aid decision-making. Companies may classify their costs as period and product costs. Usually, period costs include any expenses incurred during a specific time. These costs may also fall under various types, including current, historical and pre-determined period costs.