What are Period Costs?
Period costs are all other indirect costs that are incurred in production. Overhead and sales & marketing expenses are common examples of period costs.
Period cost refers to all those costs which are not related or tied with the production process of the company, i.e., they are not assigned with any of the particular products of the company and are thus shown in the financial statement of the company for the accounting period in which they are incurred.
These costs are apportioned as expenses against the revenue for the given tenure. Period costs are also termed Period expenses, time costs, capacity costs, etc. Some examples include General Administration costs, sales clerk Salary, depreciation of office facilities, etc.
Based on association, costs can be classified into the product and period expenses. Product costs are a cost that is allocated to products and are to be formed as part of inventory valuation. These costs are not associated with production and should not form part of inventory valuation . Generally, unavoidable costs are considered as period expenses.
Understanding Period Costs
In managerial and cost accounting, period costs refer to costs that are not tied to or related to the production of inventory. Examples include selling, general and administrative (SG&A) expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office. The costs are not related to the production of inventory and are therefore expensed in the period incurred. In short, all costs that are not involved in the production of a product (product costs) are period costs.
Types of period costs
Here are three classifications of period expenses:
- Current expense: Expenses that the company obtains relating to the current period
- Historical expense: Expenses that have already been incurred in the previous period which should not be considered in decision making
- Pre-determined expenses: Expenses that companies estimate for a future period calculated to prepare the budget which should be considered while making decisions
Common period costs
Here are some common types of period costs that business may have:
- Legal and professional fees: Lawyers, accountants and other advisors that businesses may pay for
- Office expenses: Expenses such as supplies, rent and other office-related expenses
- Utilities: Water, electric, gas and other utilities
- Advertising and promotion: Marketing expenses such as commercials, social media ads and other promotional items
- Maintenance and repairs: The upkeep of the office and payments for damages on any equipment that requires repairs
- Travel, meals, and entertainment: Expenses acquired during business trips
- Salaries: The money companies pay to their employees for their work
- Employee benefits: Expenses such as retirement accounts, health insurance and other employee benefits
- Insurance: Businesses usually have insurance costs to cover their assets
- Interest on loans and other liabilities: Many businesses must pay interest back on loans each month
- Automobile expense: Any company vehicles that are not related to manufacturing or delivery of products
Importance of Period Costs
Period Costs play a vital role in the running of the business. Some of the importance of period costs are as follows:
- Period cost is not directly related to the production of inventories but are key for the running of the business. Period costs include all the other indirect expenses which form a key role in the financial success of the business.
- The evaluation of the period costs helps the management of the company for proper planning as the period costs forms a vital role in evaluating the financials of a company or organization. The period costs are directly charged in the profit & loss account of a company and hence are important in the calculation of profit or loss earned by the company.
- Evaluation of period costs helps the management to keep track of the fixed costs to be incurred which are not much dynamic in nature.
How to calculate and report period costs
There is no standard approach or formula that businesses and accountants use to calculate period costs. Most often, management accountants must pay close attention to a business’s expense and determine which ones are period costs and which ones are production costs before they add them to the income statement. Once they are on the income statement, the accountant may subtract them from the gross profit to get their net income for the period.
Here are some steps you may take to report period costs for your business:
1. Keep track of your period costs
Make sure you track how much money you spend on period costs and expense them during the period you incur the costs. You may keep receipts, employee pay stubs, invoices and other documents that reflect how much money you pay out for various period costs.
2. Include your period costs on your income statement
When you expense period costs, they end up on your income statement and reduce your net income. You may choose to separate period costs by category on your income statement to gain a better understanding of what your costs are and how much you spend on each. This helps you to assess your expenses and gives you an accurate idea of your net income. Your income statement also includes your cost of goods sold, taxes and total revenue for the accounting period.
3. Reevaluate your period costs each year
Many period costs aren’t fixed. When you determine your budget each year, you may reduce expenses by reevaluating your period expenses. For example, if you change insurance premiums or even switch to a company with premiums that aren’t as costly, the price difference would need to be noted. Reevaluating your period costs may help you identify opportunities to reduce your expenses.
Advantages of Period Costs
The study & evaluation of the period costs proves advantageous to the management of the company in the following ways
As the primary objective of any entity is to produce and sell its products or services, the period costs help the entity to manage all the other activities expenses which may not directly relate to the production of goods but are vital to the operation of making a profit by the company through the business.
Period cost is generally less volatile or dynamic in nature. The study of the period expenses which are continuously rising or reporting increment in upcoming periods helps the management to take proper actions and steps to identify the need & reason for such increments and helps in reducing the same through which the financials of the company may yield better profit.
The management and study of period costs helps the management & operation team to reduce the cost incurred in the period expenses and deduce the best way of implying the cost and yielding the best outcome or result out of it.
Example of Period Costs
The following illustrates costs incurred by a manufacturing company in the first year of operations:
$10,000 in direct materials related to the production of a product;
- $50,000 in salaries related to production workers;
- $5,000 in rent for the company’s corporate office;
- $2,000 in marketing campaigns;
- $300 electricity bill related to the company’s production facility; and
- $20,000 in salaries related to the company’s accountants.
Of the items above, which are period costs that should be expensed in the period incurred?
Answer: $5,000 in rent for the company’s corporate office, $2,000 in marketing campaigns, and $20,000 in salaries related to the company’s accountants are period costs, as they do not relate to the manufacture of products. As such, the total amount of $27,000 should be expensed in the first year of operations.