Period costs are also known as period expenses, time costs, capacity costs, and operating expenses. In order to keep your budget efficient, it is important to know how to report period costs, but unfortunately, there is no standard formula for calculating period costs. The standard costs that a business incurs that are not directly related to production operations or inventory costs but still must be added to their income statement are known as period costs. Typically, these costs are unavoidable business costs and include things such as legal and professional fees, office expenses, utilities, advertising and promotions, maintenance and repairs, travels, meals, and entertainment, salaries, employees benefits, insurance, interests on loans, and other liabilities, automobile expenses, etc.
What are Period Costs?
Period costs are also known as period expenses and are charged to the income statement of a company for the period in which the expenses were incurred. Period costs are not directly related to the production of a product and are not part of the cost of goods sold. Period costs can be divided into two categories: selling costs and administrative costs with three different types of period costs. The types of period costs include historical expense, current expense, and predetermined expense. Historical expenses are expenses that are related to the previous accounting period. Current expenses are the expenses that are incurred during the current accounting period. Predetermined expenses have not yet occurred but are based on future estimates so that a budget can be prepared.
Where are Period Costs Located?
Period costs are typically located on the income statement for the accounting period in which they are incurred. Prepaid expenses are reported on the income statement for the accounting period in which they are used or for when they expire. Period costs can be separated by category on the income statement to help understand what the costs are and how much is spent on each. This way you’ll have a better idea of the expenses and give a better idea of the net income of your company.
What are the Examples of Period Costs?
Listed below are the examples of Period Costs.
- Selling: Marketing expenses and commission for salespeople are period costs because they can be separated from the production process and are not directly tied to inventory.
- Administrative: Administrative costs make up most of the non-production expenses. Items like rent and utilities on office space are common administrative expenses and are considered period costs.
- Depreciation: Fixed assets are expensed over their useful life and the depreciation expense counts as a period expense.
- Income tax: Business income taxes are period costs.
- Loan interest payments: Interest on loans is considered a business expense and a period cost.
What Effect Does Period Cost Have on the Income Statement?
Period costs reduced net income when they are expensed on the income statement. Period costs take from the revenue of a company during that accounting period and thus will have an impact on the net income for that period. Period costs are only reported on the income statement for the period in which they are used up or incurred. So, it is only for that accounting period that period costs will reduce the net income.
What is the Period Costs Formula?
As mentioned before, there is no clear formula for calculating period costs. Instead, management will need to examine the records of a period’s costs and identify each cost that is not directly related to the production of inventory but is instead charged to the statement of profit and loss.
How to Calculate Period Cost?
You will need to follow these steps to calculate the period cost.
- Locate your income statement to use as a checklist.
- On the income statement, add a small column to the right of the expenses.
- Ask yourself if the expense was used for production or if it could be a period cost.
How to Report Period Cost?
Reporting period costs are based on the revenue for which they are incurred and the accrual for a specific accounting period. These expenses are charged to the statement of profit & loss and are not directly related to production.
- Period cost on the income statement would include all the operating expenses for that accounting period, such as rent, depreciation, utility bills, bad debts, insurance, salaries and wages, interest expense, and others.
- Period cost on the balance sheet would exclude any prepaid expense that does not match the revenue for the current year. Accrued expenses for the year are included as period costs.
- Period costs on the statement of cash flow are expenses that match the current period’s revenue only.
How to Determine a Period Cost?
To determine whether an expense is a period cost, you will need to follow these steps:
- First, determine if the expense was part of the production.
- Second, determine if the expense was incurred during that accounting period.
Period costs are not incurred during the manufacturing process and cannot be assigned to cost goods manufactured. They are also expensed during the period in which they are incurred.
Why is it Necessary to Keep Track of Period Costs?
The period cost is important and a necessary thing to keep track of because it allows you to know your company’s net income for each accounting period. Keeping track of the period of cost is also important for filing accurate business taxes and for preparing for an audit. Tracking period costs will also help a business balance its budget and gain savings. It will also allow a business to focus on growing and controlling direct costs.
What is the Difference Between Period Cost and Product Cost
Period costs are not tied to a product or the cost of inventory like product costs are. Period costs are also listed as an expense in the accounting period in which they occur. Unlike period costs, product costs are tied to the production of a product. Some examples of what a product costs include, direct labor, raw materials, manufacturing supplies, and overhead that is directly tied to the production facility, such as electricity.
Are Period Costs Considered Liabilities?
A liability is defined as something that a company owes to somebody else. Liabilities are normally things that are settled over time through the transfer of money, goods, or services. Liabilities can either be short-term obligations that are due within one year of a normal accounting period, or they can be long-term liabilities and are not due for more than one accounting period. By definition, period costs are costs that are incurred during one accounting period and are not tied to the production of a product or the inventory costs. If liability is short-term and due within one accounting period and is not directly tied to the production of a product or inventory costs, then it could be considered a period cost. A good example of this would be the interest incurred on a loan for office equipment that isn’t directly tied to the production of products, as long as that interest is paid within the accounting period.
