What Is Included in a Company’s Period Costs?
Discover what period costs are and how these essential operating expenses shape a company's financial health.
Companies incur various expenses to operate, and understanding how these costs are classified is fundamental to assessing financial health. Period costs represent expenses that are not directly tied to the production of goods or services. Instead, they are associated with the passage of time and are expensed in the accounting period in which they occur. These costs are crucial for evaluating a company’s overall profitability and operational efficiency, providing insights into the expenses necessary to keep a business running regardless of its production volume.
Period Costs Versus Product Costs
Distinguishing between period costs and product costs is essential for proper financial reporting and analysis. Product costs, also known as inventoriable costs, are directly linked to the manufacturing or acquisition of goods intended for sale. These typically include direct materials, direct labor, and manufacturing overhead. Product costs “attach” to the product and are initially recorded as inventory on the balance sheet. They only become an expense, specifically Cost of Goods Sold, when the related product is sold.
Conversely, period costs are not associated with the creation of inventory or the production process. They are expensed immediately in the accounting period when they are incurred, regardless of when any products are sold. This distinction means period costs are treated as expenses of the period, while product costs are treated as assets until the goods are sold. This different accounting treatment significantly impacts how a company’s profitability is calculated and presented.
Common Examples of Period Costs
Period costs encompass a broad range of expenses. These costs are often categorized into selling and administrative expenses. Other non-operating expenses also fall under this category.
Selling expenses are incurred to market, sell, and distribute products or services to customers. These can include salaries and commissions for sales staff, advertising campaigns, and promotional materials. Costs related to shipping finished goods, travel for sales meetings, and maintaining sales offices also fall into this category.
Administrative expenses cover the general management and overhead costs of a business. This category often includes executive and administrative staff salaries and benefits, office rent, and utilities for administrative spaces. Common examples also feature accounting and legal fees, office supplies, and depreciation on administrative assets.
Other period costs include interest expense on borrowed funds. Research and development (R&D) costs, aimed at creating new products or processes, are expensed as period costs. Income taxes, levied on a company’s profits, represent another period cost.
How Period Costs Appear in Financial Statements
Period costs are recognized as expenses in the period they are incurred and are primarily reported on a company’s income statement. They are presented below the gross profit line, typically as part of operating expenses, such as selling, general, and administrative (SG&A) expenses. This means they are not included in the Cost of Goods Sold.
Expensing period costs immediately reduces a company’s net income for that specific period. This direct impact on profitability reflects the costs of operating the business for a given time frame. Understanding where these costs appear provides stakeholders with insight into the company’s operating efficiency and its ability to generate profit from its core activities after accounting for non-production related expenses.