How To Find Period Cost

Decoding Period Costs: A Comprehensive Guide for Businesses

Finding and accurately calculating period costs is crucial for any business, regardless of size or industry. Understanding these costs, which are expensed in the period they are incurred, is essential for accurate financial reporting, informed decision-making, and ultimately, profitability. This comprehensive guide will unravel the complexities of period costs, providing you with a clear understanding of what they are, how to identify them, and how to effectively manage them for optimal business performance. We'll delve into various examples, offer practical tips, and address frequently asked questions, ensuring you have a firm grasp of this critical accounting concept.

What are Period Costs?

Period costs, unlike product costs (which are directly associated with producing goods), are expenses that are not directly tied to the production of goods or services. Instead, they are expensed in the accounting period in which they are incurred. Think of them as the overhead costs necessary to keep the business running. These costs support the business's operations but don't contribute directly to the creation of inventory. Accurate identification and classification of period costs are vital for determining a company's profitability and making sound financial decisions. The failure to properly account for these costs can lead to inaccurate financial statements and flawed business strategies.

Key Characteristics of Period Costs

Several key characteristics differentiate period costs from product costs:

Incurred during a specific period: These expenses are recognized and recorded in the accounting period in which they occur, regardless of whether they contribute directly to production.
Not directly traceable to products: Unlike direct materials or direct labor, period costs cannot be directly linked to the production of specific goods or services.
Expensed immediately: They are charged to the income statement in the period they're incurred, rather than being capitalized as part of inventory.
Support business operations: These costs are essential for the smooth functioning of the business, covering areas like administration, marketing, and sales.

Categorizing Period Costs

Period costs are generally categorized into several key areas:

Selling Expenses: These are the costs associated with marketing, selling, and distributing products or services. Examples include:
- Sales salaries and commissions: Compensation paid to sales representatives.
- Advertising and promotion: Costs associated with marketing campaigns and promotional activities.
- Sales supplies: Materials used in the sales process (e.g., brochures, stationery).
- Shipping and handling: Costs of transporting products to customers.
- Sales office rent and utilities: Expenses related to maintaining sales offices.
General and Administrative Expenses (G&A): These encompass the costs involved in the overall management and administration of the business. Examples include:
- Salaries of administrative staff: Compensation for executives, managers, and administrative personnel.
- Rent and utilities: Expenses for office space, electricity, and other utilities.
- Office supplies: Costs of materials used in the office (e.g., stationery, printing).
- Insurance: Premiums for various types of insurance policies.
- Legal and professional fees: Costs incurred for legal services and professional advice.
- Depreciation: The allocation of the cost of long-term assets over their useful life. (Note: while depreciation can relate to production equipment (a product cost), it also applies to office equipment, which is a period cost.)
- Research and development: Costs related to developing new products or improving existing ones (can be debatable, often treated as a period cost unless directly tied to a specific product in development).
Research and Development (R&D) Costs: Although sometimes categorized separately, R&D costs are often considered period costs unless directly attributable to a specific product under development. This is because the benefits of R&D often extend beyond a single accounting period.
Interest Expense: The cost of borrowing money. While interest on loans used to finance the production of goods might be considered part of product costs, interest on general business loans is usually considered a period cost.

How to Find Period Costs

Finding period costs involves a systematic review of your company's financial records and a careful classification of expenses. Here's a step-by-step approach:

Review your Chart of Accounts: Your chart of accounts provides a detailed listing of all your accounts. Carefully examine expense accounts to identify those unrelated to production.
Analyze your Income Statement: Your income statement categorizes expenses. Focus on the selling, general, and administrative expense sections.
Examine your Supporting Documentation: Supporting documents like invoices, receipts, and bank statements provide detailed information about each expense. This helps in accurately categorizing them.
Consult with an Accountant: If you're unsure about the classification of specific expenses, seeking professional guidance from a qualified accountant is advisable. They possess the expertise to ensure accurate classification and compliance with accounting standards.
Use Accounting Software: Accounting software can automate much of the process of tracking and categorizing expenses, making it easier to identify period costs.

Illustrative Examples

Let's illustrate with a few examples:

Example 1: A bakery pays its administrative assistant's salary. This is a general and administrative expense, a period cost.
Example 2: A clothing retailer spends money on a national television advertising campaign. This is a selling expense, a period cost.
Example 3: A software company pays rent for its office space. This is a general and administrative expense, a period cost.
Example 4: A manufacturing company pays insurance for its factory. While part of this might be allocated to production (product cost), a portion covering the administrative offices is a period cost.
Example 5: A restaurant pays for its wait staff. This is a selling expense (period cost). However, the cost of the ingredients for the food is a product cost.

Distinguishing Period Costs from Product Costs

It's crucial to differentiate between period and product costs. Product costs (also known as inventoriable costs) are directly related to manufacturing goods and include:

Direct Materials: Raw materials that become part of the finished product.
Direct Labor: Wages paid to workers directly involved in production.
Manufacturing Overhead: Indirect costs associated with production, such as factory rent, utilities, and depreciation of factory equipment.

Product costs are capitalized as part of inventory and are only expensed when the goods are sold (as Cost of Goods Sold – COGS). Period costs, conversely, are expensed immediately when incurred.

Impact of Period Costs on Profitability

Period costs significantly impact a company's profitability. Higher period costs directly reduce net income. Effective management of these costs, therefore, is critical for maintaining healthy profit margins. This involves strategies like:

Negotiating better deals with suppliers: Reducing costs for office supplies, utilities, or insurance.
Improving operational efficiency: Streamlining administrative processes to reduce labor costs.
Optimizing marketing and advertising spending: Focusing on cost-effective marketing strategies.
Regular cost analysis: Regularly reviewing expenses to identify areas for potential cost savings.

Frequently Asked Questions (FAQ)

Q1: Can a cost be both a period cost and a product cost?

A1: No, a cost cannot be both a period cost and a product cost simultaneously. The classification depends on its direct relationship to production. However, some costs may have components that are classified differently. For example, factory insurance might be partially a product cost (allocated to production) and partially a period cost (covering administrative offices).

Q2: How do period costs affect the calculation of gross profit?

A2: Period costs do not affect the calculation of gross profit. Gross profit is calculated as Revenue – Cost of Goods Sold (COGS). Period costs are subtracted from gross profit to arrive at net income.

Q3: What accounting standards govern the treatment of period costs?

A3: Generally Accepted Accounting Principles (GAAP) in the US and International Financial Reporting Standards (IFRS) internationally provide guidance on the proper classification and accounting treatment of period costs.

Q4: What happens if period costs are misclassified as product costs?

A4: Misclassifying period costs as product costs will inflate the value of inventory and understate the cost of goods sold. This will lead to an overstatement of net income in the current period and an understatement in future periods when the inventory is sold.

Q5: How can I improve the accuracy of my period cost tracking?

A5: Implementing a robust accounting system, using accounting software, regular expense reviews, and seeking professional advice can significantly improve the accuracy of your period cost tracking.

Conclusion

Understanding and effectively managing period costs is fundamental to sound financial management and business success. By carefully reviewing your financial records, accurately classifying expenses, and employing effective cost-management strategies, you can gain valuable insights into your business's operational efficiency and profitability. Remember to seek professional assistance if needed, ensuring that your financial reporting is accurate and compliant with relevant accounting standards. The accuracy of your period cost accounting directly impacts the reliability of your financial statements and the quality of your business decisions. By mastering this essential concept, you’ll be well-equipped to navigate the complexities of business finance and make informed decisions that drive growth and profitability.