Period Costs Meaning
Period cost refers to all those costs which are not related or tied with the production process of the company i.e., they are not assigned with any of the particular product of the company and are thus shown in the financial statement of the company for the accounting period in which they are incurred.
These costs are apportioned as expenses against the revenue for the given tenure in which they are incurred. Period costs are also termed as a Period expense, time cost, capacity costs, etc., and some examples include General Administration cost, sales clerk Salary, depreciation of office facilities, etc.
Based on association, costs can be classified into the product and period expenses. Product costs are a cost that is allocated to products and are to be formed part of inventory valuation. These cost not associated with production and should not form part of inventory valuationInventory Valuation Inventory Valuation Methods refers to the methodology (LIFO, FIFO, or a weighted average) used to value the company's inventories, which has an impact on the cost of goods sold as well as ending inventory, and thus has a financial impact on the company's bottom-line numbers and cash flow situation.. Generally, unavoidable costs are considered as period expenses.
Types of Period Costs
- Historical Expense – Expenses relating to the prior period. Such costs are already incurred and are irrelevant during decision making.
- Current Expense – Expenses relating to the present period.
- Pre-Determined Expense– Expenses based on estimates of a future period. Such costs are computed in advance for the preparation of the budget, by considering all the factors that can affect such cost. Such costs are to be kept well in mind while doing the decision making.
Period Cost Formula
There is no clear cut formula for calculating this cost. There is even no fixed approach in identifying the period expense in all the particulars. The Management accountant has to carefully evaluate the time cost and check whether the same will form part of an income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. or not.
Time cost forms a significant portion of indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc., hence very much critical for running the business.
#1 – Fixed Cost
The best example is the Fixed CostFixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.. Fixed costs are costs, which remain constant for a given tenure, irrespective of the level of output. Generally, fixed cost consists of fixed production overhead and Administration Overhead. The fixed cost per unit of output will vary inversely with changes in the level of output. As output increases, fixed cost decreases and vice – versa. Fixed cost is treated as a time cost and therefore charged to the Profit and Loss Account
It will keep on accruing, and an entity will have to bear the same, without any fact of earning a profit or any revenue. Examples of Fixed costs are rent, salary, insurance, etc.
#2 – Usage of Period Expense in Inventory Valuation
Valuation of inventory can be done by either weighted average or FIFO methodFIFO MethodUnder the FIFO method of accounting inventory valuation, the goods that are purchased first are the first to be removed from the inventory account. As a result, leftover inventory at books is valued at the most recent price paid for the most recent stock of inventory. As a result, the inventory asset on the balance sheet is recorded at the most recent cost.. Weighted-average costing mixes current period expenses with the costs from prior periods that are in beginning inventory. This mixing makes it impossible for managers to know the current period expense of manufacturing the product. First-in, first-out (FIFO) costing addresses this problem by assuming that the first units worked on are the first units transferred out of a production department.
FIFO separates current period expenses from those in beginning inventory. In FIFO costing, the costs in beginning inventory are transferred out in a lump sum. FIFO costing does not mix costs from prior tenure (that are in beginning inventory) with a current period expense.
#3 – Capacity Cost
Resources consumed in a period to provide or maintain the organization’s capacity to produce or sell are known as capacity costs or supportive overheads. Capacity costs further divide into standby costs and enabling costs. Standby costs will continue if the firm shuts down operations or facilities temporarily. Examples are depreciation, property taxes, and some executive salaries.
The firm will not incur enabling costs if operations shut down, but will incur them if operations take place at all. Some of these will likely be constant over the entire output range; others will likely vary in steps. For example, a single-shift operation might require only one departmental supervisor, but the operation of a second shift will require a second supervisor.
Reporting of Period Cost
Time Costs are reported based on
- Revenue for which they are incurred
- Tenure got over and needed to be charged to profit and loss account
- Accrual for a specific accounting periodSpecific Accounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.
Disclosure in Financial Statement
Period expenses appear on the income statement with an appropriate caption for the item in the period when the cost is incurred or recognized.
Relevance for Decision-making
For Decision making, all period expenses are irrelevant. However, in below mentioned exceptional situations, it is needed to be considered for decision-making:
- When they are specifically incurred for any contract;
- When they are incremental in nature;
- When they are avoidable or discretionary
- When they are incurred instead of another
If one wants to summarize, cost classifications have been proved useful to management. Cost analysts have developed a number of the different costs that help them in the classification of costs for a variety of managerial applications. Different purposes require different cost constructs.
Time cost, being part of cost classificationCost ClassificationCost Classification is the process of segregating costs of the company into different categories that gives a fair idea to the decision-maker about the spending pattern. This bifurcation allows teams to efficiently use the data for accounting purposes and for financial modeling which leads the management to decide which cost is important than others. based on association, helps management to understand the burden of cost that firm is facing irrespective of the fact that the company is working or not, earning any kind of profit or not, the company is utilizing full capacity or not. It helps management in knowing what the irrelevant unavoidable costs are there, that will always be considered to reach the breakeven pointBreakeven PointBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost..
This article has been a guide to what are Period Costs and its definition. Here we discuss the types and formula of period expense along with its relevance for decision making. You can learn more about accounting from the following articles –