Question

Why do managers need to understand product and period costs, what are their differences?

Answer 1

Following are the reasons for understanding product and period costs:

• Calculation of correct value of inventory

Product cost is included in the value of inventory. If value of inventory is unsold, the portion of product cost will be carryforward to the next period. In case of period cost, the entire cost will be expensed in the period in which it is incurred.

• Calculation of cost of each unit produced

Only product cost will be included in the calculating the cost of each unit produced. If there is no classification of product cost and period cost, accurate cost of product cannot be known.

• Accurate income computation

If there is no classification is done, entire period and product cost will be expensed. so that the income will be understated.

Following are the difference between the product and period cost:

1. Product cost are incurred if products are produced. Period cost are incurred even if no units produced or sold.
2. Most of the components of product cost are variable. Most of the components of period cost are fixed.
3. Product cost are form part of inventory. Period cost are not form part of inventory.
4. Product cost are expensed when units sold. Period cost are expensed when incurred.
5. Examples of product cost are direct materials, direct labor, overheads. Examples of period cost are administration and selling expenses.