Costs Included in Inventory

While accounting for inventories it is important to determine the costs that should be included in the inventory. The costs that are included in the inventories are called inventoriable costs or product costs and are capitalized and shown in the inventory account on the balance sheet. This is done because expenses must be matched against the revenue they produce. A manufacturer does not incur costs of production until the goods are sold.  Before that time, the costs are capitalized, that is, part of inventory as an asset. Inventories of manufactured goods should include all costs incurred to manufacturer and prepare them for sale, including:

  • Materials used in the manufacturing process,
  • Labor of manufacturing workers, and
  • A portion of overhead that related to manufacturing.

When the goods are sold, the costs are released from inventory as expenses (typically called COGS) and matched against sales revenue.

There are certain costs that are not capitalized, and are instead recognized as expense in the year in which they are incurred. These are called period costs. These costs include:

  • Selling and administrative expenses
  • Storage costs
  • Abnormal waste (of materials, labor or overheads)

Some examples of period costs are advertising, executive salaries, sales commissions, public relations, and other nonmanufacturing costs. For manufacturing companies, period costs include all non-manufacturing costs such as research and development, distribution, sales, etc. For service companies, all of their costs are period costs.

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