Save 30% on all 2023 Study Packages with Code: BLACKFRIDAY30. Valid until Nov. 28th.

Costs Included in Inventories and Costs Recognised as Expenses

Costs Included in Inventories and Costs Recognised as Expenses

The amounts reported as ‘inventories’ and ‘cost of goods sold’ are two significant items that can appear on a company’s financial statements, especially for manufacturing and merchandising companies. Some costs are included in the asset ‘inventories,’ while others are recognized as expenses on the income statement in the period in which they are incurred.

The inclusion of costs in inventory defers their recognition as an expense on the income statement until the inventory is sold. Additionally, a company that includes costs in inventory that should rightfully be expensed will overstate the profitability reported on its income statement, as well as create an overstated inventory value on the balance sheet.

Costs Included in Inventories

Both US GAAP and IFRS stipulate that the costs that are to be included in inventories are “all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.”

Costs of purchase include the purchase price, import and tax-related duties, transport costs, insurance during transportation, handling costs, and other costs that are directly attributable to the acquisition of finished goods, materials, and services. The costs of purchase, as well as the price paid, are reduced by trade discounts, rebates, and similar items.

Costs of conversion include all costs that are directly related to the units produced, for example, direct labor costs, and fixed and variable overhead costs.

Costs Recognized as Expenses

Under both IFRS and US GAAP, the costs that are excluded from inventory include abnormal costs that are incurred as a result of material waste, labor or other production conversion inputs, storage costs (unless required as part of the production process), and all administrative overhead and selling costs.

These excluded costs are treated as expenses and recognized on the income statement during the period in which they are incurred.

Question

Which of the following costs should a company recognize as expenses?

  1. Abnormal waste, storage, and selling costs.
  2. Raw materials, overhead, and direct labor costs.
  3. Handling costs, transport, and administrative costs.

Solution

The correct answer is A.

Abnormal waste, storage, and selling costs are all usually recognized as expenses.

B is incorrect. It provides costs that are usually included in inventories.

C is incorrect. It gives a combination of costs that are included in inventories (handling costs and transport costs) and some that are usually expensed (administrative costs).

Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Shop Actuarial Exams Prep Shop GMAT® Exam Prep


    Sergio Torrico
    Sergio Torrico
    2021-07-23
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    diana
    diana
    2021-07-17
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    2021-07-16
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    2021-06-28
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Marwan
    Marwan
    2021-06-22
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    2021-05-10
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    2021-03-24
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    2021-03-18
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.