Where Would Period Costs Be Found on the Financial Statements?
Explore where period costs appear on financial statements and their direct influence on a company's reported profit.
Financial statements are formal records of a company’s financial activities and position, offering a comprehensive overview of its health. They allow stakeholders to assess profitability, liquidity, and overall performance. These documents provide transparency and accountability, helping users make informed decisions.
Defining Period Costs
Period costs are expenses recognized in the accounting period they are incurred, regardless of when associated revenue is generated. These costs are not directly tied to the production of goods or services. Instead, they support the general operations of a business over a specific time frame.
Common examples of period costs include administrative salaries for office staff, rent for corporate office space, utility bills for non-manufacturing facilities, and marketing expenses like advertising campaigns. Research and development costs, as well as general overhead expenses not related to manufacturing, also fall into this category. Unlike costs that become part of inventory, period costs are expensed immediately, directly affecting the profitability of the current period.
Locating Period Costs on the Income Statement
Period costs are primarily reported on a company’s income statement. They are expensed in the period they occur, directly reducing revenue to arrive at operating income. This contrasts with product costs, which are initially capitalized as inventory on the balance sheet and expensed as cost of goods sold only when the related products are sold.
On the income statement, period costs are found below the Gross Profit line. They are often grouped under headings such as “Selling, General, and Administrative (SG&A) Expenses” or “Operating Expenses.” SG&A expenses encompass a wide range of non-production costs, including sales commissions, advertising, office rent, and administrative salaries. These operating expenses include various period costs like “Salaries Expense,” “Rent Expense,” and “Marketing Expense,” which lead to Operating Income.
The Impact of Period Costs on Financial Performance
The treatment of period costs influences a company’s reported financial performance and profitability. Since these costs are expensed in the period they are incurred, they immediately reduce the net income for that specific period. This direct impact means they are important for assessing a company’s short-term financial health and operational efficiency.
Managing period costs effectively is important for controlling overhead and improving the bottom line. For financial analysts and investors, examining these costs helps evaluate how well a company manages its non-production expenditures and its overall operating efficiency. Higher period costs, if not offset by increased revenue, can lead to lower operating margins and reduced profitability, impacting financial ratios that stakeholders use to gauge a company’s financial health.