What is Fixed Overhead?

Fixed overhead is a set of costs that do not vary as a result of changes in activity. These costs
are needed in order to operate a business. One should always be aware of the total amount of
fixed overhead costs that a business incurs, so that management can plan to generate a
sufficient amount of contribution margin from the sale of products and services to at least
offset the amount of fixed overhead. Otherwise, it is impossible to generate a profit.

Since fixed overhead costs do not change substantially, they are easy to predict, and so
should rarely vary from the budgeted amount. These costs also rarely vary from period to
period, unless a change is caused by a contractual modification that alters the cost. For
example, building rent remains the same until a scheduled rent increase alters it.
Alternatively, the recognized impairment of a fixed asset may reduce the amount of
depreciation expense associated with that asset.Examples of fixed overhead costs that
can be found throughout a business are rent, insurance, office expenses, administrative
salaries, depreciation, and amortization.

 Examples of fixed overhead costs that are specific to a production area (and which are
usually allocated to manufactured goods) are factory rent, utilities, production
supervisory salaries, and normal scrap. Other production overhead costs include
materials management staff compensation, quality assurance staff compensation,
depreciation on production equipment, and insurance on production equipment, facilities,
and inventory.Rent for manufacturing facilities.
 Factory office rent and supplies.
 Factory administrative office salaries.
 Depreciation of production equipment.
 Salaries paid to non-hourly employees such as production floor supervisors.
 Materials management staff compensation.
 Quality assurance staff salaries.
 Insurance and property taxes on plant equipment, inventory and facilities.
 Machine supplies.
 Repairs and maintenance.
 Sanitation personnel.
Product Costs Versus Period Costs
All costs, both manufacturing and nonmanufacturing, can be classifified as
either product costs or period costs. As discussed in previous chapters,
product costs (or inventory costs) are assigned to Work in Process as
production occurs and subsequently transferred to Finished Goods as
products are completed. When inventory is sold, product costs are recog
nized as an expense (cost of goods sold) and matched with the related
revenues from the sale of the products. In contrast, period costs are not
assigned to the product but are recognized as expenses in the period
incurred. All nonmanufacturing costs are period costs. These include
selling expenses as well as general and administrative expenses.

Product cost refers to the costs incurred to create a product. These costs include direct
labor, direct materials, consumable production supplies, and factory overhead. Product
cost can also be considered the cost of the labor required to deliver a service to a
customer. In the latter case, product cost should include all costs related to a service,
such as compensation, payroll taxes, and employee benefits.

Product cost can be recorded as an inventory asset if the product has not yet been sold. It
is charged to the cost of goods sold as soon as the product is sold, and appears as an
expense on the income statement.

What are Period Costs?

Period costs are costs that cannot be capitalized on a company’s balance sheet. In other
words, they are expensed in the period incurred and appear on the income statement. Period
costs are also called period expenses.

In managerial and cost accounting, period costs refer to costs that are not tied to or related to
the production of inventory. Examples include selling, general and administrative (SG&A)
expenses, marketing expenses, CEO salary, and rent expense relating to a corporate office.
The costs are not related to the production of inventory and are therefore expensed in the
period incurred. In short, all costs that are not involved in the production of a product
(product costs) are period costs.

Period Costs vs. Product Costs

Product Costs Period Costs

Definition: Costs related to the production of a product Costs not related to the production o
product

Method of Capitalized on the balance sheet as inventory and Expensed on the income statement
Recording: eventually expensed to cost of goods sold on the period incurred
income statement

Examples: Direct labor, direct materials, and manufacturing Marketing expense, selling, general
overhead administrative expense, and CEO sa

All costs incurred by a company are either period costs or product costs. Additionally, the two
types of costs are recorded differently. See the table below for more comparison:

To quickly identify if a cost is a period cost or product cost, ask the question, “Is the cost
directly or indirectly related to the production of products?” If the answer is no, then the cost
is a period cost.