Identifying Product and Period Costs
The way a company classifies a cost depends on the category the cost falls into. Using generally accepted accounting principles (GAAP), business costs fall into the two general categories in the following list:
Product costs: Any costs that relate to manufacturing or merchandising an item for sale to customers. A common example is inventory, which reflects costs a manufacturing company incurs when buying the raw materials it needs to make a product. For a merchandiser (retailer), the cost of inventory is what it pays to buy the finished goods from the manufacturer.
Period costs: Costs that, although necessary to keep the business’s doors open, don’t tie back to any specific item the company sells. You can also think of period costs as costs you incur due to the passage of time, such as depreciation, rent, interest on a loan, and insurance premiums.