There are two types of expenses in managerial accounting: period costs and product costs. A period cost is defined as all costs in the profit and loss statement that is not a cost directly associated with a product, also known as “Sales, General and Administrative costs” (SG&A). A product cost is the total amount of cost that is directly associated with a product, also known as a cost of goods sold.
Period costs fall under the general, administrative, and sales expenses section of the profit and loss statement. These expenses are operational and should be expensed within the period they are incurred. They are expected to benefit the revenues in that period and are not anticipated to benefit future revenues. Use the matching principle, which matches the expenses to the revenues. Examples of period costs include rent, office supplies, wages, and marketing and advertising expenses.
Product costs or the cost of goods sold are located just below the revenue in the profit and loss statement and offset revenue to calculate the gross margin. These expenses need to be recognized in the same period in which the revenue was recognized, again following the matching principle. For example, a company that resells a third party software would need to invoice the customer in June to match all June costs associated with working and delivering that product.
Separating these expenses is very important to a business. Understanding Period Costs or SG&A is critical to calculating monthly expenses and calculating required top line revenue requirements. Understanding Product Costs or Cost of Goods Sold is critical to calculating product prices, sales commissions, and gross margin. For more information on these two important categories, contact TGG Accounting. We are glad to help!Written by: Erika Marasigan TGG Accounting