Period Costs in Managerial Accounting

Period costs are expenses a business must pay regardless of the number of products it makes or sells. They occur during a specific period and are charged as expenses immediately. Companies pay period costs to keep their businesses running, even if they don’t make anything.

Unlike product costs, which relate directly to making items, period costs relate more to the general running of the business. For example, the salary of the company’s CEO is a period cost because they get paid the same amount whether the company makes one product or a million products.

Main Types of Period Costs

Administrative Expenses

Administrative expenses make up a large part of period costs. These include the salaries of office workers, managers, and executives. The company must also pay for office supplies, computers, and software that help run the business. Even things like paper for printers and coffee for the break room count as administrative period costs.

Selling Expenses

Selling expenses are another major period cost. These expenses help the company sell its products but don’t directly connect to making them. Sales team salaries, advertising costs, and store rent all fall under selling expenses. When a company puts up a billboard or runs a TV commercial, those costs are period costs because they aren’t tied to specific products.

Rent and Utilities

Most businesses need a place to operate. The rent for office space, warehouses, and retail stores is a period cost. Along with rent come utility bills for electricity, water, heating, and cooling. These costs stay the same monthly, no matter how much the company produces.

How Period Costs Work in Practice

Monthly Bills Example

Think about a company that makes chairs. Every month, they must pay $5,000 in office rent. Whether they make zero or thousands of chairs that month, the rent stays at $5,000. This makes it a perfect example of a period cost. The same goes for their monthly internet bill of $200—it doesn’t change based on how many chairs they make.

Yearly Costs Example

Some period costs occur once a year instead of every month. For example, a company might pay $50,000 for its yearly insurance policy. Even though they pay it once, accountants usually split this cost across all twelve months of the year. This helps them track expenses more evenly and makes financial planning easier.

Recording Period Costs

When to Record

Companies record period costs as soon as they occur. This differs from product costs, which wait until products are sold. If a business pays its monthly rent on the first of March, it immediately records that expense in March’s financial records.

Where to Record

Period costs appear on a company’s income statement. They are divided into different sections based on their type. Administrative costs go into one section, while selling costs go into another. This helps managers see where money gets spent and plan better for the future.

Why Period Costs Matter

Business Planning

Understanding period costs helps businesses plan better. Managers know they must earn enough money to cover these fixed monthly expenses. This knowledge shapes important decisions about pricing products and setting sales goals.

Cost Control

By tracking period costs carefully, companies can find ways to save money. Maybe they notice their utility bills are too high and decide to install energy-efficient lighting. Or they might find cheaper office space when their lease ends. Small savings on period costs can add up to big improvements in profits.

Financial Analysis

Investors and analysts evaluate period costs to judge a company’s business efficiency. Lower period costs often indicate an efficient operation. However, some successful companies choose to have higher period costs if they think spending more on advertising or research will help them grow.

Common Mistakes About Period Costs

Mixing Up Costs

Some people confuse period costs with product costs. The main difference is that product costs are directly related to making products, while period costs are not. The salary of a factory worker who makes products is a product cost. The wages of the accountant who tracks the money is a period cost.

Thinking All Fixed Costs Are Period Costs

While many period costs stay the same each month, not all fixed costs are period costs. Some fixed costs relate directly to production. For example, the cost of running a factory is fixed but counts as a product cost because it helps make products.

Managing Period Costs

Regular Review

Smart companies review their period costs regularly. They look for expenses that have grown too large or services they no longer need. This might lead them to cancel unused software subscriptions or renegotiate supplier contracts.

Budgeting

Companies create budgets that plan for period costs. They know these expenses will come up every month or year, so they ensure enough money is saved. Good budgeting helps prevent cash flow problems and keeps the business running smoothly.

Period Costs in Different Industries

Manufacturing Companies

Manufacturing companies often have large period costs for their office operations. However, their biggest expenses usually come from product costs in their factories. They need to balance both types of costs to stay profitable.

Service Companies

Service companies like law firms or consulting businesses might have mostly period costs. Since they don’t make physical products, most expenses are period costs. Most of their costs are office rent, professional salaries, and advertising.

Retail Businesses

Retail businesses have significant operating costs, including rent, utility bills, and sales staff salaries. However, they also have product costs from buying to selling inventory.

Modern Trends in Period Costs

Digital Transformation

Many businesses now spend more on digital tools and software. These new period costs help companies work more efficiently. While the costs might seem high initially, they often save money in the long run by reducing other expenses.

Remote Work Impact

The recent shift toward remote work has changed some period costs. Companies might spend less on office space but more on digital tools and home office stipends for workers. This shows how period costs can change as businesses adapt to new working methods.