Last editedAug 20222 min read
Any business needs to keep track of costs if they want to be profitable. But understanding the different kinds of costs is just as important as understanding overall costs as it provides the potential for a more granular approach to financial analysis and management.
The main difference between product and period costs is that the former is only counted when products are produced or acquired and the latter accrue over time. As such, businesses with no product costs might still have period costs to worry about.
But let’s delve a little deeper into the specific differences and why they are so important.
What is a product cost?
All direct costs related to production are classed as product costs. This could be anything from the cost of the raw materials and labour costs to manufacturing supplies and the overheads tied to production like energy usage.
For a typical retail business, for example, all costs involved in buying supplies and bringing products to market would be product costs. As such, these costs are used to value inventory and once those products are sold, the product costs fold into the costs of goods sold.
What is a period cost?
All costs that are not classified as product costs can be classified as period costs. These are generally the costs not directly tied to production, so include overheads and administration costs. Unlike product costs, period costs won’t be assigned to a specific product and will typically be declared an expense during whatever accounting period they occurred within.
Specific examples of period costs are the cost of rent for any facilities not used for production, marketing and advertising, interest on debt and even indirect labour - legal advisers, delivery drivers, office employees and more.
Generally, all product costs will be variable, as the amount spent will typically vary depending on multiple factors such as how much is being produced and how expensive raw materials are. It’s up to the accountant to decide if costs have already been accounted for or if they need to be calculated as part of the overall production costs.
Period costs, meanwhile, can be either fixed or variable. Note that these costs will also be calculated differently during different parts of a lifecycle. The methodology is also going to be affected by whether the calculations are being made for reports or forecasts.
Common period and product cost questions
Are overheads period costs?
Yes. Utility bills, rent, insurance and all other costs not directly related to production are booked as period costs.
How long are period costs recorded for?
This will depend on your accounting period. Generally speaking, accounting periods are either registered annually or per quarter (every three months). For most smaller businesses operating annually, that means period costs would be recorded over the course of 12 months.
Is labour a product cost?
This depends on the type of labour. If the labour in question is related to production (for example, if the employee works in manufacturing) then it’s a product cost. All other labour costs, however, including office staff and maintenance crew, will typically be classified as period costs.
We can help
Separating costs is crucial when it comes to analysing a business's cost drivers and examining the revenue required to reach economies of scale.
GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with by automating invoices so that all different costs are properly accounted for.