What Is a Period Cost? Definition and Examples

Costs are economic sacrifices incurred to achieve objectives like producing goods or providing services, reducing a company’s financial resources. Understanding how different costs are classified is fundamental for accurate financial reporting and making informed business decisions. Period costs represent a distinct category of these expenses, recognized differently from other business outlays.

Identifying Features of Period Costs

Period costs are expenditures not directly tied to the manufacturing of goods or the provision of services. Instead, these costs are expensed in the accounting period during which they are incurred. This contrasts with costs that are capitalized and then expensed over time or as goods are sold. They are commonly associated with administrative functions, selling activities, or general operational overhead.

The incurrence of period costs is independent of the volume of goods produced or services rendered. For instance, the rent for an office building remains constant regardless of whether a company manufactures one product or one thousand products. These costs are recognized as expenses in the financial statements immediately. This immediate expensing aligns with the matching principle of accounting, which requires expenses to be recognized in the same period as the revenues they help generate.

Typical Examples of Period Costs

Rent for administrative offices represents a common period cost, as it is incurred regardless of production levels and supports general business operations. Similarly, the salaries paid to administrative staff, such as human resources personnel, accounting department employees, or executive leadership, are classified as period costs.

Marketing and advertising expenses, including costs for promotional campaigns or sales team salaries, are also considered period costs. These expenditures aim to generate sales but are not directly integrated into the manufacturing process. Utility costs for office spaces, like electricity or internet services, fall into this category because they support the general work environment rather than specific production activities.

Insurance premiums for general liability coverage or office property insurance are also examples of period costs. These annual or monthly payments protect the business assets and operations. Depreciation of office equipment, such as computers or furniture, is expensed over its useful life as a period cost. Furthermore, research and development expenses, aimed at creating new products or improving existing ones, are treated as period costs and expensed when incurred.

Period Versus Product Costs

The distinction between period costs and product costs is fundamental due to their differing treatment and impact on financial statements. Product costs are directly associated with the manufacturing of goods and include direct materials, direct labor, and manufacturing overhead. These costs attach to the product itself and are only expensed when the goods are sold.

In contrast, period costs are not tied to the production process and are expensed immediately in the period they arise. For example, the cost of wood used to build a table is a product cost, while the salary of the company’s CEO is a period cost. This difference in association means product costs are initially recorded as inventory on the balance sheet, reflecting their asset nature until the goods are sold.

The timing of expense recognition further distinguishes these two cost types. Product costs become part of the Cost of Goods Sold (COGS) on the income statement only when the related inventory is sold. This means if goods are produced but not sold, their associated product costs remain on the balance sheet as inventory. Period costs, however, are recognized as expenses on the income statement as soon as they are incurred, regardless of sales activity.

This fundamental difference impacts the financial statements. Product costs initially reside on the balance sheet as an asset (inventory) and then transfer to the income statement as COGS upon sale. Period costs, on the other hand, bypass the balance sheet entirely and are immediately expensed on the income statement, directly reducing profitability in the period they occur. This distinction is important for accurate inventory valuation and income determination.

Recording Period Costs

Period costs are treated as expenses in the period they are incurred and are immediately recognized on a company’s income statement. They are typically found below the “Gross Profit” line, often categorized within sections like selling, general, and administrative (SG&A) expenses. This placement reflects their nature as costs not directly related to the cost of goods produced or services rendered.

For instance, administrative salaries, marketing expenses, and office rent are reported as part of SG&A expenses. The immediate expensing of these costs means they directly reduce a company’s net income for that specific accounting period. This contrasts with product costs, which are capitalized as inventory and only impact net income when the related goods are sold.

Because period costs do not relate to the production of inventory, they never become part of the inventory’s value on the balance sheet. This straightforward accounting treatment ensures that a company’s operational overhead is transparently reflected in its financial performance for each period.