Question

Please answer all the following parts to the following question (200 word count minimum)

Explain what financial statement inventory costs are capitalized to and why. Explain when inventory costs are incurred as an expense. What account is used to classify inventory costs as an expense?

Answer 1

Explain what financial statement inventory costs are capitalized to and why?

The cost of an item is capitalized on a company's balance sheet if the company expects to consume the item over a long period of time. Rather than being expensed, the cost of the item or fixed asset is capitalized and amortized or depreciated over its useful life.

Examples of corporate capitalized costs are expenses associated with constructing a fixed asset and can include materials, sales taxes, labor, transportation, and interest incurred to finance the construction of the asset. Expenses associated with intangible assets can also be capitalized; these include trademarks, filing and defending of patents, and software develop.

Explain when inventory costs are incurred as an expense?

Inventory costs can be classified as follows:

Ordering costs. These costs include the wages of the procurement department and related payroll taxes and benefits, and possibly similar labor costs by the industrial engineering staff, in case they must pre-qualify new suppliers to deliver parts to the company. These costs are typically included in an overhead cost pool and allocated to the number of units produced in each period.

Holding costs. These costs are related to the space required to hold inventory, the cost of the money needed to acquire inventory, and the risk of loss through inventory obsolescence. Most of these costs are also included in an overhead cost pool and allocated to the number of units produced in each period. More specifically, holding costs include:

Cost of space. Perhaps the largest inventory cost is related to the facility within which it is housed, which includes warehouse depreciation, insurance, utilities, maintenance, warehouse staff, storage racks, and materials handling equipment. There may also be fire suppression systems and burglar alarms, as well as their servicing costs.

Cost of money. There is always an interest cost associated with the funds used to pay for inventory. If a company has no debt, this cost represents the foregone interest income associated with the allocated funds.

Cost of obsolescence. Some inventory items may never be used or will be damaged while in storage, and so must be disposed of at a reduced price, or at no price at all. Depending on how perishable the inventory is, or the speed with which technology changes impact inventory values, this can be a substantial cost.

Administrative costs. The accounting department pays the wages of a cost accounting staff, which is responsible for compiling the costs of inventory and the cost of goods sold, responding to other inventory analysis requests, and defending their results to the company's internal and external auditors. The cost of cost accounting personnel is charged to expense as incurred.

These may include costs incurred directly in the production of inventory such as direct labor and production overheads (i.e. conversion costs) and other expenses such as transportation and handling charges, taxes and duties that may not be recoverable from tax authorities.

What account is used to classify inventory costs as an expense?

Cost of goods sold is usually the largest expense on the income statement of a company selling products or goods. Cost of Goods Sold is a general ledger account under the perpetual inventory system.

Under the periodic inventory system there will not be an account entitled Cost of Goods Sold. Instead, the cost of goods sold is computed as follows: cost of beginning inventory + cost of goods purchased (net of any returns or allowances) + freight-in – cost of ending inventory.

This account balance or this calculated amount will be matched with the sales amount on the income statement.