Period Cost

A period cost is any cost that is charged to expense in the accounting period in which it is incurred, rather than being attached to inventory and expensed only when goods are sold. Period costs relate to the passage of time or to running the business as a whole, not to producing specific units. The main examples are selling expenses, such as advertising and sales commissions, and general and administrative expenses, such as office salaries, head office rent and accounting fees.

The opposite of a period cost is a product cost, also called an inventoriable cost: direct materials, direct labor and manufacturing overhead that are recorded in inventory and become cost of goods sold only when the products are sold. The distinction matters most for manufacturers, because it decides when costs reach the income statement and therefore affects reported profit and inventory values.

• Selling costs: advertising, sales salaries and commissions, trade show costs, and shipping goods to customers (freight-out).
• Administrative costs: executive and office salaries, accounting and legal fees, office rent and utilities, and depreciation on office equipment.
• Research and development, which US GAAP generally requires to be expensed as incurred.
• Interest expense on general borrowing, except where it is capitalized as part of building a long-term asset.

The same type of cost can be a product cost or a period cost depending on where it is incurred. Rent on a factory is a product cost included in overhead; rent on the head office is a period cost. Depreciation on production machinery is a product cost; depreciation on the sales team's cars is a period cost.

A furniture maker produces 10,000 tables in a year and sells 8,000. Its product costs are $1,500,000 (materials $600,000, labor $500,000, overhead $400,000), or $150 per table. Its period costs are selling expenses of $250,000 and administrative expenses of $300,000.

The income statement shows cost of goods sold of 8,000 times $150, or $1,200,000. The remaining $300,000 of product cost stays on the balance sheet as finished goods inventory for the 2,000 unsold tables. By contrast, the full $550,000 of period costs is expensed this year, regardless of how many tables were sold. If sales are $2,400,000, operating income is:

Here $\text{Sales}$ is revenue, $\text{COGS}$ is the product cost of units sold, and $\text{Period costs}$ are selling and administrative expenses for the year. The result is $2,400,000 minus $1,200,000 minus $550,000, or $650,000. If the company had mistakenly treated $100,000 of head office rent as factory overhead, $20,000 of it would have been held in inventory and operating income would have been overstated by that amount.

Under GAAP and IFRS, inventory must include all production costs but must exclude selling and administrative costs. Getting the classification wrong distorts both inventory and profit. Under absorption costing, fixed manufacturing overhead is a product cost, while under variable or direct costing, used for internal decisions, fixed overhead is treated as a period cost. The difference explains why the two methods report different profits when production and sales volumes differ. For tax, US rules under section 263A require some indirect costs that would be period costs for book purposes, such as parts of purchasing and warehousing, to be capitalized into inventory, creating book-tax differences. In service businesses, which hold little or no inventory, nearly all costs are period costs and are expensed as incurred.