The difference between what you spent to buy the inventory and what you sold it for is the profit. An understanding of period costs helps you analyze your financial statements. Materials are unprocessed examples of period costs items used in the manufacturing process. Direct materials are those materials used only in making the product and there is a clear, easily traceable connection between the material and the product.

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. 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.

Period costs vs. product costs: What’s the difference?

Businesses and accountants do not utilize a standardized approach or formula to compute period costs. Management accountants must frequently scrutinize a company’s expenses to determine which are period costs and which are production costs before adding them to the income statement. Once they’re on the income statement, the accountant can deduct them from the gross profit to calculate the period’s net income. Weighted-average costing combines current-period expenses with prior-period costs in the beginning inventory. Managers are unable to determine the current period expense of manufacturing the product as a result of this combination.

In managerial and cost accounting, period costs refer to costs that are not tied to or related to the production of inventory. Examples include selling, general and administrative (SG&A) expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office. The costs are not related to the production of inventory and are therefore expensed in the period incurred. In short, all costs that are not involved in the production of a product (product costs) are period costs.

LINE ITEM BUDGET: Benefits and Examples

This is because these expenses are close to the products, but the production of units is not affected by incurring these costs. Hence, all such expenses are treated as period costs & expenses in the statement of profit & loss. You may buy the inventory in one period (say January) and sell it in another (say June). So the expenses were incurred in the first quarter, but the sale occurred in the second quarter. If you’re doing quarterly statements, how do you match the income with the expense?