Manufacturing companies need to track both product costs and period costs. Learn the difference between these two types of costs and why each is important.
Product costs are directly related to production, while period costs are associated with overhead. Source: WallStreetMojo.
|Always related to the manufacturing process||Not affected by production levels|
|Related to volume, such as units produced or labor hours||Related to overhead and indirect costs|
|Always variable, depending on production levels||Usually fixed, but can also be semi-variable|
|Include labor, materials, supplies, and factory overhead||Includes administrative, sales, and distribution costs|
|Are recorded on a balance sheet||Are recorded on an income statement|
Final thoughts on product and period costs
Product and period costs are incurred in the production and selling of a product.
By separating these two very different cost types, you can more easily identify potential problem areas in production, such as inefficient labor, inferior machinery, or outdated procedures, while also reviewing production costs, such as raw materials and direct labor.
You’ll also be able to spot trouble spots or overspending in administrative areas or if overhead has ballooned in recent months.
Though it may be tempting to just lump your expenses together, there are three great reasons why you need to separate product and period costs for your business.
Accurate financial statements
Because product and period costs directly impact your financial statements, you need to properly categorize and record these costs in order to ensure accurate financial statements.
Speaking of financial statements, it’s important that you take the time to review your financial statements on a regular basis. As an owner, you rely on their accuracy to make key management decisions. This can be particularly important for small business owners, who have less room for error. If product and period costs are overstated or understated, or not recorded at all, your financial statements will be wrong as well.
Save time and money
Recording product and period costs may also save you some money come tax time, since many of these expenses are fully deductible. But you won’t be able to deduct them if you don’t know what they are.
Accurate pricing for your products
Finally, managing product and period costs will help you establish more accurate pricing levels for your products. Being aware of the total costs involved in manufacturing an item, including indirect costs, will help to ensure that your products aren’t priced too low or too high, but are priced to earn your business a profit, something every business owner strives to achieve.