2.3 Product Costs vs. Period Costs

Cost classification is crucial in financial reporting, affecting how businesses track expenses and report profits. Product costs, tied to manufacturing, become assets on the balance sheet until sold. Period costs, unrelated to production, are immediately expensed on the income statement.

This distinction impacts inventory valuation, profitability measures, and financial ratios. Proper classification ensures accurate reporting and informed decision-making. Misclassification can lead to overstated inventory and inaccurate profit figures, highlighting the importance of understanding these concepts in cost accounting.

Cost Classification and Financial Reporting

Product vs period costs

Top images from around the web for Product vs period costs

• 

  Production Cost | Boundless Economics View original

  Is this image relevant?

• 

  Flow of Costs (Job Order Costing) | Accounting for Managers View original

  Is this image relevant?

• 

  Product vs. Period Costs | Accounting for Managers View original

  Is this image relevant?

• 

  Production Cost | Boundless Economics View original

  Is this image relevant?

• 

  Flow of Costs (Job Order Costing) | Accounting for Managers View original

  Is this image relevant?

1 of 3

Top images from around the web for Product vs period costs

• 

  Production Cost | Boundless Economics View original

  Is this image relevant?

• 

  Flow of Costs (Job Order Costing) | Accounting for Managers View original

  Is this image relevant?

• 

  Product vs. Period Costs | Accounting for Managers View original

  Is this image relevant?

• 

  Production Cost | Boundless Economics View original

  Is this image relevant?

• 

  Flow of Costs (Job Order Costing) | Accounting for Managers View original

  Is this image relevant?

1 of 3

• Product costs directly associated with manufacturing goods encompass direct materials (raw ingredients), direct labor (factory workers' wages), and manufacturing overhead (factory utilities)
• Period costs not tied to production include selling expenses (advertising campaigns, sales commissions) and administrative expenses (office rent, executive salaries)
• Product costs also known as inventoriable costs while period costs are non-inventoriable

Treatment of product costs

• Balance sheet records product costs as inventory asset until goods sold, categorized as raw materials, work-in-process, or finished goods
• Income statement recognizes product costs as expense (Cost of Goods Sold) when inventory sold, adhering to matching principle
• Cash flow statement reflects product costs in operating activities section, with inventory level changes impacting cash flows

Period costs in income statements

• Period costs immediately expensed when incurred regardless of sales volume
• Listed separately from Cost of Goods Sold, typically grouped as Selling, General, and Administrative expenses
• Directly reduce operating income, not dependent on production levels

Cost classification impact on profitability

• Inventory valuation increases with product costs while period costs have no effect
• Gross profit calculation only affected by product costs, operating profit impacted by both cost types
• Financial ratios like inventory turnover influenced by product cost classification, profit margin ratios affected by both
• Cost-volume-profit analysis and break-even calculations consider cost classification
• Misclassification can lead to inventory overstatement/understatement and inaccurate profit reporting
• Industry-specific considerations vary between manufacturing and service companies, affecting retail inventory accounting methods