Basis: Where the cost was incurred (location/purpose)
| Type | Where Incurred | When Expensed | Balance Sheet Treatment |
|---|---|---|---|
| Product | Manufacturing facility | When product is sold | Flows through inventory |
| Period | Selling, administrative | When incurred | Never touches inventory |
The Location Test
If the cost is incurred in the factory → Product cost If the cost is incurred anywhere else → Period cost
| Role | Location | Classification |
|---|---|---|
| Factory supervisor | Manufacturing floor | Product (manufacturing overhead) |
| Marketing manager | Corporate office | Period (selling expense) |
| Assembly worker | Factory | Product (direct labor) |
| HR manager | Corporate office | Period (administrative) |
Why Location Determines Classification
A factory supervisor’s effort contributes to creating inventory—an asset with future economic value. That cost should attach to the product and become an expense when the value is realized (sale).
A marketing manager’s effort doesn’t create a storeable asset—it generates sales in the current period. Expense it now.
The Two Costs Can Both Be Indirect
| Manager | Direct/Indirect | Product/Period |
|---|---|---|
| Factory supervisor | Indirect (can’t trace to units) | Product (factory location) |
| Marketing manager | Indirect (can’t trace to units) | Period (non-factory location) |
Both are indirect. Different columns on product/period axis.
Common Trap Confusing indirect with period. A cost can be indirect AND a product cost (like manufacturing overhead). The axes are independent.
Practical Application: Journal Entries
This classification determines which account you debit:
| Cost Type | Example | Journal Entry |
|---|---|---|
| Product cost | Factory property taxes | Dr. Manufacturing Overhead / Cr. Property Taxes Payable |
| Period cost | Office property taxes | Dr. Property Tax Expense / Cr. Property Taxes Payable |
Same cost type (property taxes), different debit account based on location.
The Accrual Connection
If you’re confused about why factory costs go to MOH instead of an expense account, see Why MOH Instead of Expense?.
Product costs don’t skip the expense—they delay it until the product sells. The path: MOH → WIP → Finished Goods → COGS → Income Statement.
North: Where this comes from
- Cost Classification Framework (one of three axes)
- Matching Principle (expense recognition should match revenue recognition)
East: What opposes this?
- Direct vs Indirect Costs (traceability axis, not location axis)
South: Where this leads
- Inventory Valuation (product costs flow through inventory)
- Income Statement Structure (period costs hit immediately)
- Cost of Goods Sold (product costs become COGS when sold)
West: What’s similar?
- Capitalization vs Expensing (does it create future value or not?)