Question

Explain why product costs are capitalized but period costs are expensed in the current accounting period.

Short answer

Product costs are capitalized because it reflects the company’s future value, while period costs are expanded because they are used during the current period.

Step-by-step solution

Meaning of Product Cost

Product costs are the direct costs incurred in producing a product. An example of a product expense for a manufacturer would be direct labor.

Explaining why product costs are capitalized but period costs are expensed in the current accounting period.

In addition to the cost of creating a product, any expenses incurred in its creation are considered product costs. Several expenses affect these, including direct materials, direct labor, and factory overhead.

Period costs are expenses incurred during a reporting period that are not capitalized into inventory, fixed assets, or prepaid expenses.

Since product costs reflect a potential future value (an asset) for the company, they are capitalized. Because they are used up during the current period, period costs are expensed.

Product costs are as they were incurred when products are bought or delivered, but period costs are connected to the passage of time. This is often the most refinement between item costs and period costs. Since of this, a company that doesn't engage in manufacturing or stock buys will still have period costs if it doesn't have any production costs.