What is the difference between a product cost and a selling and administrative cost?
If you’re currently in business, you need a good way to manage costs. While using accounting software is the best method for managing costs, even if you’re still recording transactions in a manual ledger or using a spreadsheet application, you can learn to manage business costs properly. Show
Managing your costs is doubly important if you own a manufacturing business, since you’ll need to manage both product and period costs. Product costs, also known as direct costs or inventoriable costs, are directly related to production output and are used to calculate the cost of goods sold. On the other hand, period costs are considered indirect costs or overhead costs, and while they play an important role in your business, they are not directly tied to production levels. Both product costs and period costs directly affect your balance sheet and income statement, but they are handled in different ways. Product costs are always considered variable costs, as they rise and fall according to production levels. What are product costs?Product costs are the costs incurred during the manufacturing process. Product costs are always related to production, and typically include the following:
Accurately calculating product costs also assists with more in-depth analysis, such as per-unit cost. Per-unit cost is calculated by dividing your costs by the number of units produced. It is an important metric, particularly when determining product pricing. What are period costs?Period costs are the costs that your business incurs that are not directly related to production levels. These expenses have no relation to the inventory or production process but are incurred on a regular basis, regardless of the level of production. Period costs are typically divided into two categories: administrative costs and selling costs. Examples of period costs include:
The one similarity among the period costs listed above is that these costs are incurred whether production has been halted, whether it’s doubled, or whether it’s running at normal speed. Most period costs are considered periodic fixed expenses, although in some instances, they can be semi-variable expenses. For example, you receive a utility bill each month that is not directly tied to production levels, but the amount can vary from month to month, making it a semi-variable expense. Regardless, all period costs, whether fixed or semi-variable, are considered expenses and will be reported on your income statement. Product vs. period costs: What's the difference?Product costs are always related to production, with period costs being considered indirect or overhead costs. Think of it like this: If you stop production for a month, no product costs will be incurred. However, you’ll still have to pay the rent on the building, pay your insurance and property taxes, and pay salespeople that sell the products currently in inventory. Product costs are directly related to production, while period costs are associated with overhead. Image source: Author The table below highlights some of the differences between product costs and period costs: Product CostsPeriod CostsAlways related to the manufacturing processNot affected by production levelsRelated to volume, such as units produced or labor hoursRelated to overhead and indirect costsAlways variable, depending on production levelsUsually fixed, but can also be semi-variableInclude labor, materials, supplies, and factory overheadIncludes administrative, sales, and distribution costsAre recorded on a balance sheetAre recorded on an income statement Final thoughts on product and period costsProduct and period costs are incurred in the production and selling of a product. By separating these two very different cost types, you can more easily identify potential problem areas in production, such as inefficient labor, inferior machinery, or outdated procedures, while also reviewing production costs, such as raw materials and direct labor. You’ll also be able to spot trouble spots or overspending in administrative areas or if overhead has ballooned in recent months. Though it may be tempting to just lump your expenses together, there are three great reasons why you need to separate product and period costs for your business. Accurate financial statementsBecause product and period costs directly impact your financial statements, you need to properly categorize and record these costs in order to ensure accurate financial statements. Speaking of financial statements, it’s important that you take the time to review your financial statements on a regular basis. As an owner, you rely on their accuracy to make key management decisions. This can be particularly important for small business owners, who have less room for error. If product and period costs are overstated or understated, or not recorded at all, your financial statements will be wrong as well. Save time and moneyRecording product and period costs may also save you some money come tax time, since many of these expenses are fully deductible. But you won’t be able to deduct them if you don’t know what they are. Accurate pricing for your productsFinally, managing product and period costs will help you establish more accurate pricing levels for your products. Being aware of the total costs involved in manufacturing an item, including indirect costs, will help to ensure that your products aren’t priced too low or too high, but are priced to earn your business a profit, something every business owner strives to achieve. Alert: highest cash back card we've seen now has 0% intro APR until 2024If you're using the wrong credit or debit card, it could be costing you serious money. Our expert loves this top pick, which features a 0% intro APR until 2024, an insane cash back rate of up to 5%, and all somehow for no annual fee. In fact, this card is so good that our expert even uses it personally. Click here to read our full review for free and apply in just 2 minutes. What are selling and administrative costs?Operating expenses—also known as selling, general and administrative expenses (SG&A)—are the costs of doing business. They include rent and utilities, marketing and advertising, sales and accounting, management and administrative salaries.
Is administrative cost a product cost?Administrative expenses are costs incurred to support the functioning of a business, but which are not directly related to the production of a specific product or service.
What is a product cost?Product costs are the direct costs involved in producing a product. A manufacturer, for example, would have product costs that include: Direct labor. Raw materials. Manufacturing supplies.
Are selling and administrative expenses treated as product costs?2. Under variable costing, only the variable manufacturing costs are included in product costs. Note that selling and administrative expenses are not treated as product costs under either absorption or variable costing; that is, they are not included in the costs that are inventoried.
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