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Product Costs and Period Costs

Introduction

Costs, when categorized according to the timing of charge against revenue, can be classified into: (1) product costs and (2) period costs.

In a Nutshell

Product costs, also known as inventoriable costs, are classified as assets (part of inventory) until products are sold. In other words, they are charged against revenue only when they are sold. Common example are: materials, labor and overhead costs that make up WIP and finished goods.

Period costs are directly charged against revenue. They never form part of inventories. Selling, administrative, and tax expenses are period costs.

Product Costs

Product costs refer to inventoriable costs. These costs are included as part of inventory and are charged against revenues as cost of sales only when the products are sold. In other words, they are initially classified as assets and are transferred to expense when they are sold.

All manufacturing expenses, costs incurred in the factory or production process, (i.e., direct materials, direct labor, and factory overhead) are product costs. Direct materials, direct labor, and factory overhead are combined to form the products to be sold, hence the term "product costs".

In the accounting records, the cost of finished products is accumulated in an inventory account - usually "Finished Goods Inventory". When goods are sold, the cost is transferred from "Finished Goods Inventory" in the balance sheet to "Cost of Sales" (or Cost of Goods Sold) in the income statement.

Period Costs

Period costs are charged immediately against revenue. Unlike product costs, they are classified as expenses right away. They are not included in inventory.

Period costs include selling and distribution expenses, and general and administrative expenses. These costs are presented directly as deductions against revenues in the income statement.

Examples

Classify the following costs as (PR) product costs or (PE) period costs.

  1. Salaries of factory workers
  2. Social security - factory workers
  3. Travel expense - executives
  4. Rework costs for defective products
  5. Fringe benefits - administrative
  1. Legal fees
  2. Insurance on office building
  3. Overtime - factory workers
  4. Advertising expense
  5. Leather in producing shoes

Answers: 1. PR; 2. PR; 3. PE; 4. PR; 5. PE; 6. PE; 7. PE; 8. PR; 9. PE; 10. PR

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