Updated July 17, 2023
Definition of Period Costs
Period costs are the costs or expense incurred for the organization but does not directly relate to any of the activities which are related to the production of the inventory and thus are charged in the income statement or profit & loss statement of the entity for the period in which the cost was incurred i.e., selling & administrative expenses etc.
Explanation
Period costs are basically the expenses which could be charged to income statement of the company for the period in which such expenses have been incurred. These expenses are not directly related to the production of inventory and thus does not form part of the cost of goods sold and are charged in the income statement of the company. These costs does not constitute to production of inventory and hence these costs can never be capitalized and always form part of the income statement of the company. Examples of these costs are Selling cost, overhead costs, advertisement costs etc.
How to Calculate Period Costs?
There is no specific method or formula for calculation of period costs. For calculating the period costs the management could track the records of period costs and identify those costs which are charged in the statement of profit & loss and are not directly related to production of inventories. This way the management could identify the expenses that could be classified as period costs and it will become easy to evaluate and compare the same figure with the figure in the previous years.
Examples of Period Costs
For understanding the concept better, let’s take an example:
Example #1
A manufacturing company ABC Inc. records some of the expenditures incurred in the month of June 2020 & through the evaluation of the same the company wants to determine the total period costs incurred in the month of June 2020. The records of the expenditures are as follows:
| Direct Materials used in manufacturing of products | 10,000.00 |
| Direct wages | 5,000.00 |
| Salary for accounts department | 25,000.00 |
| Electricity Bill of the factory for the month | 700.00 |
| Advertisement expenses | 4,000.00 |
Solution:
Calculation of Period Cost-
| Salary for accounts department | 25,000.00 |
| Advertisement expenses | 4,000.00 |
| Total Period Costs | 29,000.00 |
The expenses that are compiled for the calculation of Period costs are not related Other expenses will not be considered as a period cost because they are directly related to the process of production of inventory.
Types of Period Costs
Period costs could be classified into three categories & the categories are as follows:
- Historical Period Expenses: These expenses are the period expenses that are already incurred or occurred in the previous prior periods & are not to be considered for any decision making done for the current period. These could only be considered for any comparison purpose.
- Current Period Expenses: These expenses are the period of expenses which has been incurred in the current period by the company. These are the expenses which management considers for evaluating the current situation and financial position of the company and use the data and the fact for the decision making for the current period.
- Pre-Determined Period Expenses: These expenses are the period expenses that are expected to be incurred in the future time period by the company as per the evaluation made by the management after considering trends and many other factors that would affect the same figures in the future. These expenses are used by the management while preparing budgeting for the upcoming periods.
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.
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.
Conclusion
Period cost is as vital as the product cost incurred by the entity. The period costs could not be capitalized as they are not directly related to the production of the inventory and hence are charged in the profit and loss statement of the company. The better management of the period costs helps the entity to identify the expenses and the areas of expenses where the same service or better services and results could be obtained through less expenditure to the company. The management of the period cost helps the company to prepare better budgeting and able the entity to use the increased profit in expanding the business through which the entity will yield more profit.
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