Molly Ayala
In accounting, costs are classified as either inventoriable (or product) costs or period costs. Inventoriable costs are incurred to acquire, manufacture, or construct a product, and they are initially assigned to inventory. They are considered assets and are recorded on the balance sheet. When the inventory is sold, these costs are transferred to the income statement as the cost of goods sold (COGS). On the other hand, period costs are all the costs that are not included in product costs. They are not directly tied to the production process and are treated as expenses in the period they are incurred. Examples of period costs include rent, advertising, and salaries for non-production personnel. So, is electricity an inventoriable or period cost? The answer may vary depending on the context and the specific accounting system used by a company. However, electricity consumed in a factory or manufacturing plant can be considered a manufacturing overhead cost and, therefore, an inventoriable cost.
| Characteristics | Values |
|---|---|
| Definition | Inventoriable costs are costs incurred to acquire, manufacture or construct a product. Period costs are all the costs not included in product costs. |
| Other names | Product costs, manufacturing overheads (inventoriable costs); Overhead, SG&A (period costs) |
| Examples | Direct materials, direct labour, manufacturing overhead (inventoriable costs); Rent, utilities, advertising, salaries for non-production personnel (period costs) |
| Accounting treatment | Inventoriable costs are initially recorded as inventory and expensed when sold. Period costs are expensed in the period they are incurred. |
| Industries | Inventoriable costs vary across industries and down the supply chain. For instance, for a retailer, inventoriable costs include all costs related to the acquisition of the product from the manufacturer to its premises, whereas for a manufacturer, their inventoriable costs are direct material, direct labour, and all manufacturing overheads. In a service concern, all the costs are considered period costs. |
| Benefits | Inventoriable costs benefit future periods, whereas period costs benefit the current period. |
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What You'll Learn
Electricity as a manufacturing overhead cost
Electricity is considered a manufacturing overhead cost. Manufacturing overhead refers to indirect costs related to making products. These costs are incurred to support the manufacturing process but are not directly tied to a specific product. They are essential for the manufacturing process to function and are typically recorded as expense accounts.
Examples of manufacturing overhead costs include electricity to run machinery in a factory, factory utilities, cleaning supplies, machine depreciation, and salaries of non-production staff. These costs are necessary for production but are not directly related to the creation of a specific product.
Manufacturing overhead costs are calculated by adding up all the indirect costs incurred by a factory. These costs can be fixed, variable, or semi-variable. Fixed costs remain the same regardless of production volume and can include items such as rent, depreciation, and certain types of maintenance, repair, and operations (MRO) inventory. Variable costs change with production volume and may include labour costs and utility bills.
To optimise efficiency and reduce manufacturing overhead costs, businesses can minimise waste, improve energy usage, and automate routine tasks. Additionally, implementing modern software can help track indirect costs, identify inefficiencies, and streamline processes to lower expenses.
In summary, electricity is a significant component of manufacturing overhead costs, encompassing the electricity required to power machinery and equipment in a factory. These costs are essential for the manufacturing process but are not directly attributed to a specific product. By understanding and effectively managing these costs, businesses can improve their financial performance and energy efficiency.
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Electricity as a period cost
Electricity is considered a period cost. Period costs are expenses not directly related to inventory and are tied to the passage of time. They are expensed in the period they are incurred and are treated as expenses for the period in which they arise. They are not part of the manufacturing process and are not included in product costs.
Electricity is a cost incurred to operate manufacturing machinery and is, therefore, a manufacturing overhead cost. Manufacturing overhead costs are fixed costs directly related to the manufacturing of a product. They are considered period costs because they are expensed in the period they are incurred and are not tied to the production of inventory.
In the context of a manufacturing plant, electricity is a cost incurred to enable the production of goods. It is not a direct cost associated with the manufacturing or acquisition of a product, nor is it a raw material or direct labour cost. As such, it is not an inventoriable cost. Inventoriable costs are costs that become part of inventories and are initially assigned to inventory as assets. They are not expensed until the inventory is sold and revenue is generated.
As a period cost, electricity is treated as an expense in the period it is incurred, regardless of whether any inventory is sold. This means that it is recorded as an operating expense on the income statement of the relevant period. It is important to differentiate between inventoriable and period costs for accurate financial reporting and effective business management.
It is worth noting that the classification of costs can depend on the context and the specific accounting or costing system used by a company. For example, in a service-sector company, all costs are considered period costs because there are no inventories. In this case, electricity would still be considered a period cost, but the reasoning behind the classification may differ.
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Inventoriable costs
In manufacturing, inventoriable costs can be defined as all direct material, direct labour, and manufacturing costs. These costs are incurred while the product is being manufactured but are not expensed to the profit and loss accounts in the same period. These costs become part of three types of inventories and sit on the balance sheet. When these inventories become finished goods and are sold, inventoriable costs transform into the cost of goods sold, thereby becoming part of the profit/loss statement.
In trading concerns, the acquisition costs of goods sold in the same form are considered inventoriable costs. These include the purchase cost of goods, freight cost, handling, and all other costs necessary to bring goods in a position to be sold by the trader. In a service concern, all the costs are considered period costs because there are no inventories in the service sector.
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Product costs
Direct materials refer to the tangible raw materials or components directly used in the production of a product. This includes items that become part of the final product and can be directly traced to the manufacturing process. For example, the fabric used to make clothing or the steel utilized in fabricating furniture. The cost of direct materials includes the purchase price as well as any incidental costs associated with acquiring and storing these materials.
Direct labor refers to the wages and salaries paid to employees directly involved in the production process. This includes workers who physically assemble, fabricate, or construct the product. Direct labor costs also encompass benefits, overtime pay, and any other expenses directly associated with these employees. These costs are essential in transforming raw materials into finished goods and are directly proportional to the volume of production.
Manufacturing overhead, also known as indirect manufacturing costs, are expenses incurred in the manufacturing process but are not directly attributable to a specific product or production run. These costs are necessary for the overall operation of the manufacturing function and may include items such as rent for the factory building, depreciation of manufacturing equipment, utilities like electricity used in the production process, indirect labor (e.g., supervisors or quality control staff), and other indirect materials. Manufacturing overhead is allocated to products based on an appropriate base, such as machine hours, direct labor hours, or direct materials cost.
It is important to note that product costs do not include selling, general, and administrative expenses, which are classified as period costs. Product costs are specifically related to the production process and are capitalized as part of inventory until the goods are sold. Once the products are sold, these costs are then transferred from the inventory account to the cost of goods sold expense account, matching the expense with the revenue generated from the sale. This process ensures that the cost of producing the inventory is reflected in the income statement during the period in which the revenue is recognized.
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Expenses and income statements
An income statement is a financial report that summarizes a company's financial performance over a specific accounting period. It includes a company's revenue, expenses, gains, and losses. It is also known as the profit and loss (P&L) statement. The income statement provides valuable insights into a company's operations, efficiency, management, and performance relative to others in the same sector.
The income statement is divided into time periods that logically follow the company's operations. The most common periodic division is monthly for internal reporting, while certain companies may use a thirteen-period cycle. These periodic statements are then aggregated into total values for quarterly and annual results.
The income statement starts with the details of sales and then works down to compute net income and eventually earnings per share (EPS). It does not differentiate between cash and non-cash receipts or payments/disbursements. The income statement covers a specific time frame, which is indicated in its heading.
Expenses are an integral part of the income statement. They are classified as either inventoriable (product) costs or period costs. Inventoriable costs are incurred to acquire, manufacture, or construct a product, and they are initially assigned to inventory. These costs are expensed only when the inventory is sold and revenue is generated. On the other hand, period costs are all the costs that are not included in product costs. They are treated as expenses for the period in which they arise and are not tied to a particular product or inventory.
In the context of electricity, it is considered an inventoriable cost or product cost. This is because electricity is consumed in the manufacturing process and is necessary for the production of goods. Therefore, electricity costs would be initially recorded as inventory and then transferred to the cost of goods sold when the products are sold.
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Frequently asked questions
Inventoriable costs, also known as product costs, are incurred to acquire, manufacture, or construct a product. They are initially assigned to inventory and expensed only when the inventory is sold.
Period costs are all costs not included in product costs. They are not part of the manufacturing process and are treated as expenses for the period in which they arise.
The cost of electricity required to operate manufacturing machinery is a manufacturing overhead cost and is, therefore, an inventoriable cost.
Other examples of inventoriable costs include raw materials, direct labour, and factory overheads. Period costs include selling, general, and administrative expenses, such as rent, utilities, advertising expenses, and salaries of personnel not involved in production.
