How to Find Period Costs in Accounting
Learn to identify and manage period costs effectively for accurate financial reporting and deeper insight into your company's operational expenses.
Period costs are fundamental expenses in business accounting, reflecting expenditures tied to a specific accounting period rather than directly to the creation of goods or services. These costs are essential for a business’s operations, supporting various functions that enable revenue generation. Identifying and managing period costs offers crucial insights into a company’s financial health and operational efficiency. Accurately distinguishing these costs from other types of expenditures is important for precise financial reporting and informed decision-making.
Understanding Period Costs
Period costs are expenses that are recognized in the accounting period in which they are incurred, regardless of when any products related to those expenses are sold. These costs are more closely linked to the passage of time than to the production process itself. Unlike manufacturing costs, which become part of inventory, period costs are treated as operating expenses that support the general functioning of a business. They are often considered necessary to keep the business running, even if no production occurs.
The accounting treatment of period costs aligns with the matching principle, a core concept in accrual accounting. This principle dictates that expenses should be reported in the same period as the revenues they help generate. For period costs, if no direct cause-and-effect relationship with specific revenue can be established, they are expensed immediately in the period they occur. This ensures that a company’s financial statements accurately reflect its performance by matching all relevant costs with the period’s economic activity.
Identifying Common Period Costs
Administrative salaries, such as compensation for executives, office managers, and support personnel, are common examples of period costs because they are not directly tied to manufacturing a product. Rent for office spaces or corporate headquarters is also a period cost, incurred to house administrative functions. These expenses are necessary for the overall management and operation of the business.
Marketing and advertising expenses, which include costs for promotional campaigns, sales commissions, and travel, also fall under period costs. These expenditures aim to generate sales but are not directly embedded in the cost of producing an item. Research and development (R&D) costs are another type of period cost, expensed as incurred due to uncertain future benefit. Depreciation on office equipment is treated as a period cost since it relates to non-manufacturing assets.
Distinguishing Period Costs from Product Costs
Product costs are directly associated with the manufacturing or acquisition of goods, including direct materials, direct labor, and manufacturing overhead. These costs are “inventoriable,” meaning they are initially recorded as an asset on the balance sheet as part of inventory. They only become an expense, Cost of Goods Sold (COGS), when the related product is sold. This capitalization reflects that product costs provide a future economic benefit.
In contrast, period costs are not tied to the production process and are expensed immediately in the accounting period they occur. They do not become part of inventory and are treated as operational expenses. The core criterion for differentiation is whether a cost is directly related to making a product. This distinction significantly impacts inventory valuation and the calculation of Cost of Goods Sold, influencing a company’s reported profitability.
How Period Costs are Reported
Period costs are displayed on a company’s income statement, typically appearing below the Cost of Goods Sold section. They are categorized under operating expenses, often grouped as selling, general, and administrative (SG&A) expenses. This presentation reflects their nature as costs incurred to support overall business operations rather than directly producing goods.
Expensing period costs in the period they are incurred directly impacts a company’s net income. These costs reduce revenue to arrive at operating income, providing a clear picture of the costs associated with running the business’s core activities. Unlike product costs, which remain on the balance sheet as inventory until sold, period costs do not appear as assets on the balance sheet, as they are consumed within the reporting period. This reporting method is crucial for stakeholders to assess a company’s operational efficiency and profitability.