Product Costs and Period Costs: Videos & Practice Problems
Product Costs and Period Costs are separated by whether a cost helps make or acquire a product and by when the cost is recognized. Under the matching principle, costs tied to revenue are recorded in the same period as that revenue. Product costs are manufacturing or acquisition costs that attach to products, so they are not recognized immediately. Instead, they are tracked through inventory until sale. Period costs do not contribute to production, so they are recognized right away as selling, general, and administrative expenses.
For a manufacturing firm, product costs move through raw materials inventory, work in process inventory, and finished goods inventory before becoming cost of goods sold when the product is sold. Direct materials, direct labor, and manufacturing overhead are all product costs, including indirect factory costs such as repair or janitorial work. Finished goods are completed but unsold, while work in process includes partially completed products.
Merchandizing firms also have product costs, but they usually use one inventory account for merchandise held for sale. Service firms do not have product costs; all service costs are treated as period costs because there is no physical product to attach costs to.
Product Costs and Period Costs
Product Costs and Period Costs
An accountant tells their colleague that a delivery driver’s salary is a product cost, because customers wouldn’t be able to get the product without the delivery driver. This accountant is:
Correct, all costs associated with getting the product to a customer are product costs.
Correct, all costs that a business pays are indirectly related to producing products, so they are all product costs.
Incorrect, the delivery driver is an indirect cost, so it does not qualify as a product cost.
Incorrect, the delivery driver does not produce or acquire new products for sale, so their salary is a period cost.
Which of the following is a period cost for a firm that produces laptop computers?
RAM memory
Workers who assemble laptops
The accounting department
A repairman at the laptop factory
The Manufacturing Production Process
The Manufacturing Production Process
Which of the following items would be recorded as part of a clock company’s Work in Process Inventory?
A completed grandfather clock
A partially finished alarm clock
A wooden bird for a coocoo clock made by another company
A timing screw for an antique clock
A company files for bankruptcy, and as part of the process they are required to report on the value of unsold products that are completely produced. The company could find this amount as the value of their ________ inventory.
Cost of Goods Sold
Finished Goods
Work in Process
Raw Materials
Manufacturing, Merchandising, and Service Costs
Suppose that a company provides tax preparation to businesses. Which of the following would be a product cost for this business?
The wage of tax preparers
The cost of tax preparation software
The cost of ink used to print forms
None of the above
A firm that buys ice cream from a local dairy and combines it with fresh baked cookies to make ice cream sandwiches is which type of business?
Manufacturing
Merchandising
Service
Hybrid
Here's what students ask on this topic:
Product costs are costs directly involved in making or acquiring a product, such as direct materials, direct labor, and manufacturing overhead. These costs are not recognized immediately; instead, they are tracked through inventory accounts (raw materials, work in process, finished goods) and recognized as cost of goods sold when the product is sold. Period costs, on the other hand, are not tied to production and include expenses like marketing and administrative costs. These costs are recognized immediately in the period they are incurred as selling, general, and administrative expenses. The key difference lies in timing and association with revenue, following the matching principle, which states that costs should be recognized in the same period as the related revenue.
Manufacturing firms use three main inventory accounts to track product costs: raw materials inventory, work in process inventory, and finished goods inventory. Raw materials inventory records the cost of materials purchased but not yet used. When production begins, these costs move to work in process inventory, which includes costs of partially completed products plus direct labor and manufacturing overhead. Once products are completed, costs transfer to finished goods inventory, representing completed but unsold products. Finally, when the product is sold, these costs are recognized as cost of goods sold on the income statement. This process ensures product costs are matched with the revenue they generate, adhering to the matching principle.
Merchandizing firms buy finished products from manufacturers and resell them, so they have only one inventory account called inventory, which tracks goods purchased but not yet sold. Their product costs are simpler, involving just the cost of merchandise. Service firms, however, do not have product costs because they provide intangible services rather than physical products. All costs in service firms are treated as period costs and recognized immediately as selling, general, and administrative expenses. Unlike manufacturing firms, service firms do not use inventory accounts or cost of goods sold since there is no physical product to track.
The matching principle in accounting requires that costs be recognized in the same period as the revenues they help generate. For product costs, which are directly tied to products, this means costs are recorded as inventory when incurred and only recognized as expenses (cost of goods sold) when the product is sold, matching the revenue period. Period costs, which are not linked to specific products or revenues, are recognized immediately in the period they are incurred as selling, general, and administrative expenses. This principle ensures financial statements accurately reflect profitability by aligning costs with related revenues.
Manufacturing overhead costs include indirect costs related to production that cannot be directly traced to a specific product, such as janitorial salaries, factory repairs, and utilities. These costs are necessary for the manufacturing process and are therefore considered product costs. They are included in manufacturing overhead and allocated to products through inventory accounts. Like direct materials and direct labor, these overhead costs are not expensed immediately but are capitalized as part of product costs and recognized as cost of goods sold when the product is sold, following the matching principle.
