Period costs

What it means

Period costs are costs that are not assigned to products but charged against profit in the period in which they arise. Typical examples are administration, selling and marketing costs, research and finance costs. They are never included in inventory valuation.

The opposite is product costs, which become part of the valuation of work in progress and finished goods and reach the income statement only when the goods are sold. If a company produces goods in December and sells them in January, product costs show up in January, while period costs are already recognised in December.

The split depends on the costing method. Under absorption costing, fixed production overheads are included in product valuation; under variable costing, only variable costs are, and all fixed overheads are period costs.

How it works in practice

Under Slovak rules, the own production cost of products comprises direct costs and the part of indirect costs relating to production. Administrative and selling overheads are not included in the valuation of own-produced inventory, with rare exceptions, and are period costs.

The correct split affects reported profit. If a company mistakenly includes marketing costs in inventory valuation, it overstates inventory and profit in the year of production. With growing inventory it may report a better result than reality warrants.

For management decisions it helps to know which costs are period costs that arise regardless of volume. This supports pricing and the assessment of whether to accept an order at a lower price that only partly covers overheads.

What to watch out for

Wrongly treating costs as product costs can cause problems in a tax audit if it shifts profit between periods. The rules for valuing own inventory should be set out in an internal policy and applied consistently.

For services, which are not stored, the distinction between period and product costs is less obvious but still matters for work in progress. Unfinished work on a large job at year end may be inventory, and its valuation affects the result.