The key difference between product costs and period costs is that product costs are only incurred if products are acquired or produced, and period costs are associated with the passage of time. Thus, a business that has no production or inventory purchasing activities will incur no product costs, but will still incur period costs.
Product costs are initially recorded within the inventory asset. Once the related goods are sold, these capitalized costs are charged to expense. This accounting is used to match the revenue from a product sale with the associated cost of goods sold, so that the entire effect of a sale transaction appears within one reporting period’s income statement.
Examples of product costs are direct materials, direct labor, and allocated factory overhead. Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities.
Period costs are sometimes broken out into additional subcategories for selling activities and administrative activities. Administrative activities are the most pure form of period costs, since they must be incurred on an ongoing basis, irrespective of the sales level of a business. Selling costs can vary somewhat with product sales levels, especially if sales commissions are a large part of this expenditure.
Product costs are sometimes broken out into the variable and fixed subcategories. This additional information is needed when calculating the break even sales level of a business. It is also useful for determining the minimum price at which a product can be sold while still generating a profit.