Last editedSep 20222 min read
The cost of production is an essential component of basic business accounting. Breaking down your business’s costs can help you calculate profit more accurately as well as assist with financial forecasting. When looking at typical costs, you’ll often see these separated into product vs. period cost. In this guide, we’ll define the similarities and differences between product and period costs so that you can keep better track.
What is cost of production?
To better understand the different types of costs recognized in accounting, it’s helpful to first answer the question: what is cost of production? This calculation breaks down all costs involved with creating or producing a company’s goods or services. These include the cost of everything from raw materials to employee wages, shipping costs, and machinery. Costs involved in production can be both direct (as with raw materials), or indirect (as with administrative costs). This is why it’s helpful to divide them into separate categories for accounting purposes: product vs. period costs.
What is a product cost?
Product costs are those related directly to the cost of production, including things like direct labor, materials, and factory overhead. For example, a retailer would include the cost of any purchases from suppliers as well as the cost of shipping these items to a retail unit.
In accounting, product costs are usually measured as part of the inventory. They’re often broken down into subcategories of fixed and variable costs, which can be used for calculating things like the break-even point. When a company sells its products, the product costs form part of the cost of goods sold (COGS) on the income statement.
What are period costs?
Period costs describe a business’s additional costs incurred during a specific reporting period. While they still form part of the overall cost of running a business, they aren’t directly related to manufacturing a specific good or service.
Examples of period costs include administrative expenses like office supplies, utilities, depreciation, and rent. Interest expenses, marketing, and corporate sales costs are also included in this category. These are incurred whether the business manufactures or acquires goods and are considered indirect costs of production. Rather than being listed as inventory, period costs are listed as expenses for each accounting period.
Understanding product vs. period cost
When comparing product vs. period cost for your business, the key difference boils down to:
Product costs are incurred when goods are produced or purchased
Period costs are incurred despite production
A business can go through periods where it doesn’t have any product costs, but there will still be period costs as these are unrelated to the ebb and flow of production. Instead, they’re related to the passing of time and any time-based expenses like utility bills and rent.
Both types of costs can be fixed or variable within this framework. While product costs are often variable as they directly relate to the quantity of units produced, things like operational spaces and machinery maintenance can be fixed.
The cost of labor is unique in that it can be both a product and period cost. This depends on whether the labor is directly related to production or not – a factory worker's wages would be product costs, while a company secretary’s wages would be period costs.
Both types of costs are an important component of your business’s financial statements, so it’s helpful to set up a real-time reporting system using accounting software. GoCardless blends seamlessly with numerous accounting partners, including Xero. This ensures a joined-up workflow to help you track all costs of production while taking payments for goods and services at the same time.
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