Product vs. Period Cost: A Way to Segregate Costs

In order to do this segregation of costs, you need to understand the difference between manufacturing, merchandising, and service firms.

Then, you will be able to understand the difference between a product cost, which is a cost that goes into inventory on the balance sheet, and a period cost, which is a cost that goes into expenses on the income statement.

Product costs are only for manufacturers. That is, the product costs category only applies to companies that build their inventory. Period costs apply to all companies, since these are primarily the operating expenses on any income statement.

Manufacturing vs. Merchandising vs. Service

A manufacturing organization is one that buys raw materials and builds its inventory and then sells the inventory that it built. Therefore, these organizations will have three separate inventories among their current assets on the balance sheet. They will have raw materials, which are goods awaiting use in production; that is, waiting to be used inside the factory. They will have work-in-process, an account for the partially completed units inside the factory. And they will have finished goods, which are units that have been completed and are awaiting sale to the customers.

Merchandisers, on the other hand, do not build anything. They buy finished goods and sell them. They add what economists call place utility. Having a Toyota dealership in Harrisburg, PA saves you from having to make a trip to the factory to pick up a Toyota. Merchandisers have one inventory, which is the manufacturer's finished goods. But instead of calling it finished goods, it is called merchandise inventory.

Since they provide a service and do not sell goods, service companies technically do not have an inventory. However, they might have a parts or supplies inventory, which they might call parts or supplies or they might call inventory. If they do carry parts or supplies, it is not considered an inventory on the level of a merchandiser.

A company can have more than one type of business. For example, an automobile dealer carries a large parts inventory, and sells to the public as well as uses parts internally. The parts department is a merchandiser and the repair shop is a service business. As another example, Sam's Club is a large merchandiser. Several of its stores also have service centers for automobiles.

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