Period Costs
Period cost refers to any expense that cannot be capitalized into prepaid expenses, inventory, or fixed assets. They cannot be capitalized on a company’s balance sheet. Period costs are more closely related to the passage of time than they are to transactional events.
As period cost is always charged to expenses at once, it is better referred to as a period expense. Period costs are charged to expense in the period they are incurred.
On the income statement, this type of cost is not included in cost of goods sold. Instead, it is usually included in the selling and administrative expenses section of the income statement.
Period costs aren’t attached to one particular product or the cost of inventory like product costs. As a result, period costs are categorized as an expense in the accounting period in which they occur.
According to managerial and cost accounting, period costs are costs that are not associated with or related to the production of inventory. Some of the examples of period cost include selling, general and administrative (SG&A) expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office.
These costs are not related to the production of inventory and that’s why expense in the period is incurred. Therefore, all costs which are not involved in the production of a product are period costs.
Difference between Product cost and Period cost
| Product Cost | Period Cost |
| The costs that are related to the production of the product are known as product cost. | The costs that are not related to the production of the product is known as period cost. |
| They are directly tied to the production process. | They are not directly tied with production process. |
| It is capitalized as inventory on the balance sheet and ultimately expensed to the cost of goods sold on the income statement. | Its expenses are recorded on the income statement in the period incurred. |
| They are assigned with one particular product. | They are not assigned with one particular product. That’s why, they are listed as an expense in the accounting period in which they occurred. |
| It is a volume-oriented cost. | It is a time-oriented cost. |
| It is also known as inventorial costs. | It is also known as operating costs. |
| Some of its examples are; Direct labor, direct materials, and manufacturing overhead. | Some of its examples are; Marketing expenses, selling, general and administrative expenses, and CEO salary. |
Formula to calculate Period Cost
Period costs cannot be calculated using a specific method or formula. In order to calculate period costs, the management could examine the records of period costs and identify the costs that are not directly associated with the production of inventory but are charged to the statement of profit and loss.
Therefore, with this method, the management could identify any expenses that were categorized as period costs, making it easy to compare the figures with those from previous years.
Under Variable Costing,
Period Costs = Fixed Manufacturing Costs + General Administrative Costs + Selling and Distribution Costs
Under Absorption Costing,
Period Costs = General Administrative Costs + Selling and Distribution Costs
Types of Period Cost
The types of period cost are as follows:
Historical Period Expenses: The period expenses that are already incurred in the previous prior periods and are not considered for any decision-making to be done for the current period is known as historical period expenses. The expenses could only be used as comparison data.
Current Period Expenses: The expenses of the period expense which has been incurred in the current period by the company are known as current period expenses.
The management uses these expenses to evaluate the current situation and financial position of the firm, as well as to make decisions for the current period based on the data and facts.
Pre-Determined Period Expenses: The expenses of the period expense which are expected to be incurred in the future by the company as per the evaluation made by the management upon considering trends and many different factors that could affect these same figures in the future. These expenses are used by the management while preparing budgeting for the upcoming periods.
Importance of Period Cost
Some of the importance of period costs for running a successful business are as follows:
Period costs are key for running the business. It includes all the indirect expenses which form a key role in the financial success of the business.
Evaluation of the period costs allows the management of the company for proper planning, as they play an important role in evaluating the financials of the company.
Period costs are directly charged to a company’s profit & loss account and therefore are considered in the calculation of the company’s profit or loss.
The management can keep track of the fixed costs incurred which are not very dynamic through the evaluation of period costs.
Advantages of Period Cost
Some of the advantages of period cost are as follows:
The period costs are used to keep track of the company’s other expenses, which do not directly relate to the production of goods but significantly affect the profits made through the business.
Periodic costs tend to be less volatile or dynamic. Analyzing the period expenses which are continuously increasing or reporting increases in subsequent periods will assist management in having the ability to identify the need and reason for such increases and thus assist in reducing them, which will help the financials of the company to be more profitable.
It includes administrative, sales, distribution costs, and other indirect costs which may help the managers to prepare accurate financial statements.
Managing and studying period costs allows management and operations teams to reduce the costs incurred in the period expenses and determine the best way to imply those costs and yield the best results.
Example of a Period Cost
ABC Inc., a manufacturing company, keeps a record of some of the expenditures it made in June 2020 and, by evaluating the same, wants to determine the total monthly expenditures for June 2020. The records of expenditures consist of the following:
Direct Materials used in the manufacturing of products Rs.10,000
Direct wages Rs. 5,000
Salary for accounts department Rs.30,000
Electricity Bill of the factory for the month Rs.700
Advertisement expenses Rs.5,000
Solution:
Calculation of Period Cost
| Salary for accounts department | Rs.30,000 |
| Advertisement expenses | Rs. 5,000 |
| Total Period Cost | Rs. 35,000 |
In the above solution, the expenses which are compiled for the calculation of Period costs are not related. The other expenses mentioned there will not be considered as a period cost as they are directly related to the process of production of inventory.
Importance of Period Cost Management
A. Impact on Financial Statements
B. Cost Control Strategies
C. Budgeting and Forecasting Period Costs
A. Impact on Financial Statements:
Period cost management is crucial because it directly affects a company’s financial statements.
Proper management of period costs helps in accurately calculating net income, which is the profit a company makes after deducting all expenses.
By controlling period costs, a company can show a healthier bottom line on its income statement, making it more attractive to investors and lenders.
Improved financial statements can boost a company’s stock price and creditworthiness, which are essential for its growth and stability.
B. Cost Control Strategies:
Period cost management involves implementing strategies to control and reduce costs incurred during a specific accounting period, such as a month or a year.
Controlling these costs can involve negotiating better deals with suppliers, finding more cost-effective production methods, or eliminating unnecessary expenses.
Effective cost control strategies can help a company remain competitive in the market by offering products or services at lower prices while maintaining profitability.
It allows a business to allocate resources more efficiently, making it more agile and adaptable to market changes.
C. Budgeting and Forecasting Period Costs:
Budgeting involves planning for period costs in advance. It helps a company estimate how much it will spend on various activities and expenses during a specific time frame.
Accurate budgeting enables a company to allocate funds wisely, ensuring that there are enough resources to cover all period costs without overspending.
Forecasting, on the other hand, involves predicting future period costs based on historical data and market trends.
Effective budgeting and forecasting ensure that a company is financially prepared for upcoming expenses, preventing financial crises and promoting stability.
In conclusion, period cost management is vital for a company’s financial health and success. It impacts financial statements, helps implement cost control strategies, and aids in budgeting and forecasting period costs, all of which contribute to a company’s overall efficiency and competitiveness in the business world.
How Period Costs Affect Pricing Decisions?
Here are some bullet points explaining how period costs affect pricing decisions:
Definition: Period costs are the expenses a company incurs that are not directly tied to the production of goods or services.
Examples of Period Costs: These can include salaries of administrative staff, office rent, advertising expenses, and utilities.
Impact on Pricing: Period costs are not directly related to the production volume or sales of a specific product. However, they still affect pricing decisions in several ways:
- Cost Recovery: Businesses need to cover period costs to stay operational. Pricing must ensure that these costs are covered, so the company doesn’t operate at a loss.
- Competitive Pricing: The level of period costs can influence how a company sets its prices compared to competitors. Lower period costs may allow for more competitive pricing.
- Profit Margin: Period costs are deducted from the revenue to calculate the profit. Higher period costs can reduce the overall profit margin unless prices are adjusted accordingly.
- Break-Even Analysis: Businesses use period costs in break-even analysis to determine the level of sales needed to cover all costs, including period costs.
- Product Pricing: When deciding on the price of a specific product, businesses may consider how period costs are allocated to various products or services.
Long-Term Impact: Period costs can impact the long-term profitability and sustainability of a business. If period costs are too high, it may be challenging to maintain profitability.
Strategic Decisions: Companies may adjust their period costs through cost-cutting measures or investments in areas like marketing. These decisions can, in turn, influence pricing strategies.
Customer Perception: Extremely high prices due to excessive period costs can deter customers. Businesses need to strike a balance between covering costs and offering competitive prices.
Market Research: Companies often conduct market research to understand customer preferences and price sensitivity, taking into account both product costs and period costs.
Economic Conditions: Period costs may vary depending on economic conditions. Businesses may need to adapt pricing strategies during economic downturns or periods of inflation.
Regulatory Compliance: In some industries, there may be regulations governing pricing practices, and businesses must ensure that their pricing decisions comply with these regulations while covering period costs.
Flexibility: Period costs can change over time, so pricing decisions must be flexible to adapt to evolving cost structures and market dynamics.
In summary, while period costs are not directly tied to the production of goods or services, they play a crucial role in pricing decisions by influencing cost recovery, profit margins, competitiveness, and overall business sustainability. Businesses must carefully consider these costs when determining their pricing strategies.
Period Cost Variability and Analysis
A. Factors Influencing Period Cost Variability
B. Techniques for Analyzing and Managing Variability
Factors Influencing Period Cost Variability:
Production Volume: The number of products or services produced can affect period costs. Higher production can spread fixed costs over more units, reducing cost per unit.
Labor Costs: Changes in wages, overtime, or the number of employees can impact labor-related period costs.
Raw Material Prices: Fluctuations in the cost of materials needed for production can directly affect period costs.
Overhead Expenses: Costs like rent, utilities, and maintenance can vary based on factors like location, equipment, and facility size.
Marketing and Advertising: Expenses for advertising campaigns, promotions, and sales efforts can change from one period to another.
Regulatory Changes: Compliance with new laws and regulations may require investments in training or equipment, affecting period costs.
Technology Investments: Upgrading or implementing new technology can increase costs in the short term but may lead to long-term cost savings.
Supplier Relationships: Variability in supplier prices, quality, or delivery can impact costs and affect period cost stability.
Techniques for Analyzing and Managing Variability:
Cost Tracking: Maintain detailed records of all expenses to identify trends and fluctuations in period costs.
Budgeting: Create budgets for each period to set cost expectations and monitor actual expenses against these budgets.
Variance Analysis: Compare actual costs to budgeted costs to identify discrepancies and address areas where costs deviate.
Cost Control Measures: Implement cost control strategies such as cost reduction initiatives, negotiation with suppliers, or process improvements.
Standardization: Standardize processes and materials where possible to minimize variability and control costs.
Risk Management: Assess and manage risks that could impact period costs, like currency fluctuations or supply chain disruptions.
Benchmarking: Compare your costs to industry benchmarks to identify areas where your organization can improve cost efficiency.
Cost Allocation: Allocate costs accurately to products or services to understand their profitability and identify areas for improvement.
Continuous Improvement: Encourage a culture of continuous improvement to find and eliminate sources of cost variability.
Scenario Analysis: Consider different scenarios and their potential impact on costs, helping to prepare for unexpected changes.
By understanding the factors influencing period cost variability and employing these techniques, businesses can better manage their costs and enhance their financial stability.
Examples of Period Costs in Various Industries
A. Retail Industry
B. Manufacturing Industry
C. Service Industry
Retail Industry:
- Rent and Lease Expenses: Retailers often lease space in shopping malls or on high streets to set up their stores, incurring monthly rent or lease costs.
- Employee Wages: Retailers hire staff to assist customers, stock shelves, and manage store operations, resulting in ongoing wage expenses.
- Utilities: Costs for electricity, water, and heating/cooling are necessary to maintain a comfortable shopping environment for customers.
- Store Maintenance: Regular maintenance and repairs, such as fixing broken fixtures or replacing worn-out carpets, are essential to keep the store appealing to customers.
- Marketing and Advertising: Expenses associated with advertising campaigns, promotions, and marketing materials to attract customers to the store.
Manufacturing Industry:
- Depreciation of Equipment: Manufacturers use machinery and equipment in their production process, and these assets depreciate over time, incurring ongoing costs.
- Raw Materials: The cost of materials used in production, such as metals, plastics, or chemicals, represents a significant period cost.
- Labor Costs: The wages paid to factory workers, including assembly line workers and machine operators, are ongoing expenses.
- Factory Rent or Mortgage: Manufacturers often lease or own facilities where production takes place, leading to rent or mortgage payments.
- Insurance: Insurance premiums to cover the manufacturing facility and machinery represent a periodic cost.
Service Industry:
- Employee Wages and Salaries: Service-oriented businesses, like restaurants or consulting firms, pay wages and salaries to their employees.
- Office Rent: Companies offering services often rent office spaces to conduct business operations.
- Professional Fees: Businesses may hire consultants, lawyers, or accountants for their expertise, incurring professional fee expenses.
- Marketing and Promotion: Expenditures on advertising, online marketing, and promotional materials are common in the service industry.
- Software Subscriptions: Service-based companies may require software tools or subscriptions for their operations, leading to ongoing software expenses.
These are examples of period costs in various industries, which are incurred over time and are not directly tied to the production of goods or services. Period costs are essential for businesses to operate and maintain their facilities while attracting customers and managing their day-to-day operations.
How do companies manage and control their period costs?
Identifying Period Costs:
Companies first identify all the costs that are not directly tied to making a specific product or service.
These costs include things like rent, utilities, salaries of employees not involved in production, office supplies, and advertising expenses.
Categorizing Period Costs:
Once identified, they categorize these costs into different groups such as administrative expenses, selling expenses, and general overhead costs.
Budgeting:
Companies create a budget for their period costs, estimating how much they will spend in each category over a specific period, like a month or a year.
Expense Recording:
Every time a period cost is incurred, it’s recorded in the company’s financial records. This includes invoices, receipts, and other documentation.
Regular Financial Statements:
Companies prepare regular financial statements, like income statements and profit and loss statements, to track their period costs over time.
Cost Control:
To control period costs, companies may set spending limits or implement cost-cutting measures when actual expenses exceed the budgeted amounts.
Review and Analysis:
Periodically, businesses review their period costs to ensure they are in line with their financial goals and make adjustments as needed.
Cost Allocation:
In cases where a cost benefits multiple departments or projects, companies allocate the cost appropriately to ensure fair distribution among the different areas.
Audit and Compliance:
Companies often undergo audits to ensure that their period costs are accurately recorded and comply with accounting standards and regulations.
Continuous Improvement:
Companies aim to continually improve their cost management processes, seeking ways to reduce period costs without sacrificing quality or efficiency.
Technology and Software:
Many companies use specialized accounting software to streamline the tracking and management of period costs, making the process more efficient and accurate.
Performance Metrics:
Key performance indicators (KPIs) related to period costs, such as cost-to-revenue ratios, are monitored to assess financial health and efficiency.
Communication and Transparency:
Clear communication within the organization helps ensure that all departments understand the importance of controlling period costs and work together to achieve financial goals.
Adaptation to Changing Conditions:
Companies adjust their period cost management strategies in response to changing market conditions, economic trends, and business needs.
In summary, companies carefully plan, track, and control their period costs to maintain financial stability, allocate resources efficiently, and achieve long-term success.
FAQs on Period Costs
Which of the following is the period costs?
A) Rent on a factory building
B) Depreciation on factory equipment
C) Commissions paid on each unit sold
D) Raw materials cost
Is Insurance a period cost?
Ans: Insurance expense is a period cost. Period costs are such type of cost which is incurred business and are not directly related to production levels. These expenses do not have any relation to the inventory or production process but are incurred on a regular basis, regardless of the level of production.
Insurance expenses also do not have any relation to production process and incur in regular basis. That’s why, insurance is considered as a period cost.
What items are not included in period cost?
Ans: Period costs do not include expenses included in prepaid expenses, such as rent. Costs associated with inventory, such as direct labor, direct materials, and manufacturing overhead, are not included in period costs. As a final point, costs associated with fixed assets, such as purchased assets and capitalized interest, are not considered period costs.
How can we identify a period cost?
Ans: The entire use of a cost is consumed during the current accounting period (such as rent or utilities), whereas its use is tied to a product or is spread across more than one period, it is most likely not a period cost.
References
Accounting Tools. (2021, June 19). Retrieved from Accounting Tools: https://www.accountingtools.com/articles/what-is-a-period-cost.html
Corporate Finance Institute. (n.d.). Retrieved from Corporate Finance Institute: https://corporatefinanceinstitute.com/resources/knowledge/accounting/period-costs/
Girsch-Bock, M. (2020, October 26). the blueprint. Retrieved from the blueprint: https://www.fool.com/the-blueprint/product-vs-period-cost/
Murphy, C. B. (2021, April 30). Investopedia. Retrieved from Investopedia: https://www.investopedia.com/ask/answers/102714/what-are-differences-between-period-costs-and-product-costs.asp
Thakur, M. (n.d.). Educba. Retrieved from Educba: https://www.educba.com/period-costs/
On the income statement, which of the following would be classified as a period cost?
Objectives of Accounting – What are the Objectives of Accounting | Management Notes
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I am Smirti Bam, an enthusiastic edu blogger with a passion for sharing insights into the dynamic world of business and management through this website.
I hold a MBA degree from Presidential Business School, Kathmandu, and a BBA degree with a specialization in Finance from Apex College,
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