Determining Inventory Cost: Product vs Period

Posted in CFA by qmarks on April 2, 2010

Cost is the basis for inventory valuation. However not all costs are involved in determining the cost of inventories.

The costs known as product costs are capitalized in the Inventories account on balance sheet include

  • purchase cost
  • conversion cost
  • allocation of fixed production overhead based on normal capacity levels
  • other costs necessary to bring the inventory to its present location and condition

By capitalizing inventory cost as an asset, expense recognition is delayed until the inventory is sold

Not all inventory costs are capitalized: some are recognized as expense in the period incurred. These are the period costs:

  • unallocated portion of fixed production overhead
  • abnormal waste of materials, labor, overhead
  • storage costs (unless required as part of the production process)
  • administrative overhead
  • selling costs

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