Inventoriable Costs
Also known as product costs, are defined as costs that are attributable to the inventory and are considered to be a cost of the product.
What Are Inventoriable Costs?
Inventoriable costs, also known as product costs, are defined as costs that are attributable to the inventory and are considered to be a cost of the product.
Inventoriable costs include direct material, direct labor, other direct expenses associated with manufacturing the product, and manufacturing overheads.
These manufacturing overheads may include freight-in, purchase costs, and other costs that are required to make the product ready. Manufacturing overhead consists of indirect materials and indirect labor.
These costs are linked to manufacturing a product and ensuring that it is ready for sale. Product costs include various expenses, such as wages and salaries for factory personnel, equipment depreciation, and utilities.
Every company wants to break even, so the sales price must cover the cost per unit. This is where it is important only to include the costs necessary for calculating product costs.
Product costs include direct materials, direct labor, and manufacturing overhead, whereas COGS only includes direct material, direct labor, and variable manufacturing overhead.
Product costs are included under the balance sheet as an asset, whereas the COGS are included in the income statement.
Product costs become a part of three inventories, consisting of raw materials, work in progress, and finished goods, whereas the other does not become a part of any inventory.
Key Takeaways
- Inventoriable costs, also known as product costs, are expenses associated with manufacturing a product and preparing it for sale. They include direct materials, direct labor, and manufacturing overhead.
- Inventoriable costs are recorded in the Cost of Goods Sold (COGS) at the time of sale. They are categorized under the finished goods inventory account, aligning revenues with expenses per the matching principle.
- To calculate inventoriable costs per unit, total direct materials, direct labor, and manufacturing overhead are summed up and divided by the total number of units produced or purchased.
- Product costing helps in comparing costs, determining productivity, aiding decision-making, and understanding actual prices and profits.
- It informs resource allocation decisions and enhances cost-related performance reports.
Understanding inventoriable costs
Inventoriable costs are used in the manufacturing of a product. They are regarded as assets and listed under the cost of goods sold (COGS) at the time of sale.
Product cost factors related to manufacturing include components such as direct material costs, direct labor costs, indirect material costs, and indirect labor costs.
- Direct Material: Costs that are related to raw material costs traced to the final product. For example, if a company is a toy manufacturer, the plastic needed to make the toy would be considered the raw material.
- Direct Labor: Costs that are wages incurred to make a particular good or provide a service. For example, if a company is a table manufacturer, the people who put the table together, the workers and not the supervisor above them, will be considered direct labor costs.
- Indirect Material Costs: Costs that cannot be traced to the final product. For example, if a company is a shoe manufacturer, the indirect materials costs would be manufacturing and equipment costs, like hammers.
- Indirect Labor Costs: Wages paid to those not directly involved in producing the product. Some examples are school security guards and supervisors of a toy manufacturing company.
Manufacturing Product Unit Cost = (Direct Material Costs + Direct Labor Costs + Manufacturing Overhead) / Total Units
And, Product costs related to retailing include supply, direct labor, and overhead costs.
- Supply costs: Represents the true cost of materials, ingredients, packaging, direct labor, and direct overhead, excluding any allocation or absorption of expenses for surplus or idle capacity. Examples include factory supplies such as rugs and solvents and office supplies such as paper, pens, and forms.
- Manufacturing Overhead Costs: Those costs that are not associated with producing the final product. These costs include rent and property taxes.
Retailer Product Unit Cost = Manufacturer Product Unit Cost * 2
Product costs include heterogeneity of expenses, such as wages and salaries for factory personnel, depreciation of equipment, and utilities. They are required to list under GAAP and IFRS.
The product costs for manufacturing and retailing are different, and the accounting techniques and components used by both segments are unique.
Certain costs are unnecessary when calculating product costs, like marketing, sales, general, and administrative costs.
Accounting for inventoriable costs
The accounting process for inventoriable costs starts with recognizing the costs appropriated with the production of goods and services to be sold.
Accountants use inventory costs to record an entry in the Cost of Goods Sold (COGS) at the time of sale. They are included under the finished goods inventory account.
There is a proper flow of costs that is tracked in the financial statements of a company. These costs flow from the income statement to the balance sheet, and cash flows as well (if the payments of raw materials are paid through cash).
The first step is acquiring the materials. The purchase can be through cash or on account.
| Particulars | Amount (Dr.) | Amount (Cr.) |
|---|---|---|
| Raw Materials A/c | XXX | |
| To Cash/Accounts Payables A/c | XXX |
The second step would include the conversion of raw materials into work-in-progress.
| Particulars | Amount (Dr.) | Amount (Cr.) |
|---|---|---|
| Work-In-Progress A/c | XXX | |
| To Raw Materials A/c | XXX |
The third step will be the conversion of WIP into a final and finished product.
| Particulars | Amount (Dr.) | Amount (Cr.) |
|---|---|---|
| Finished Product A/c | XXX | |
| To Work-In-Progress A/c | XXX |
And, finally, once the product is in the final and finished stage, it is transferred to the cost of goods sold (COGS) once the goods are sold, showing the costs are recognized.
| Particulars | Amount (Dr.) | Amount (Cr.) |
|---|---|---|
| COGS A/c | XXX | |
| To Finished Product A/c | XXX |
Recording the entry under Cost of Goods Sold (COGS) helps the accountant easily match revenues with expenses.
Various departments in a corporation compute product costs, such as cost engineering, industrial engineering, design, and production; their conclusions vary in methodology and application.
Product cost data should be used to guide what management pays attention to rather than just for decision-making.
When product costs are seriously skewed, managers may pick a losing competitive strategy by de-emphasizing and overpricing highly lucrative items and extending commitments to complicated, unproductive lines.
Inventoriable costs vs. period costs
Business costs can be categorized into two types:
- Inventoriable costs
- Period costs
Inventoriable costs are incurred in one period and eliminated in another, whereas period costs are expensed as they are incurred.
Product costs include components such as direct materials, direct labor, and manufacturing overhead while manufacturing overhead only includes direct materials, direct labor, and variable manufacturing overhead.
| Aspect | Inventoriable Costs | Period Costs |
|---|---|---|
| Timing Of Recognition | On the balance sheet, product costs are recognized as assets, whereas, on the income statement, they are expensed through COGS. | No impact on the balance sheet, but they are expensed on the income statement in the period that occurred. |
| Nature Of Costs | Examples of product costs include direct material, direct labor, and fixed and variable manufacturing overheads, that are directly tied to the production of the product. | These costs aren't directly related to the production of the goods and services. Examples include marketing costs, selling and administrative costs, and R&D expenses. |
| Relationship To Inventory | Until the goods are sold, inventory costs are included in the inventory. | Period costs aren't included in the inventory, rather they are expensed in the current period. |
| Impact On Financial Statements | The increase in the balance sheet through an increase in assets. And, a decrease in the income statement through COGS. | A decrease in the net income statement in the period occurred. |
| Treatment In COGS | These costs are included in the COGS as a part of production costs during the period. | Period costs aren't included in the COGS, rather they are expensed in the period occurred. |
The main advantage of categorizing costs as products or periods is that it helps managers understand where their costs are being incurred and how they are utilized.
Inventoriable costs Advantages
Controlling costs is one important element of understanding what costs should be considered and what costs should be expensed.
Some of the advantages are:
- Accurate Product Costing: Comparing costs helps identify a product’s actual price over a given period. This enables comparing the current period with a different period. Product cost also helps determine the productivity and efficacy of the production process.
- Asset Recognition: Initially, these costs are recorded as assets on the balance sheet exhibiting the inventory value of the company.
- Cost Control: It helps to determine the cost associated with each product, allowing one to determine the actual costs and profit of a product by controlling the costs attached.
- Performance Tracking: It is also important for management-related profitability and performance reports, which frequently lead to resource allocation decisions, money transfers from unprofitable activities to lucrative activities, and improved product-cost performance.
- Decision-Making: It can also be used in the form of decision-making. When business management makes decisions, they frequently take a return on investment and how much profit a company can gain from a specific activity into account. Product costing may be used as a basis to make these judgments.
Inventoriable cost factors under absorption costing and variable costing
Technically speaking, the main difference between absorption and variable costing is how they treat the fixed manufacturing overhead. In absorption costing, the fixed manufacturing overhead is part of the product cost, whereas, in the variable costing method, it's taken as a period cost.
The inventory costs under absorption and variable costing are as follows.
Absorption Costing
Product costs under absorption costing include direct materials, direct labor, fixed manufacturing overhead, and variable manufacturing overhead.
Variable manufacturing overhead is manufacturing costs that change with an increase or decrease in production—for example, the handling and shipping of products.
Fixed manufacturing overhead is manufacturing costs that remain constant, even if there is a change in production—for example, property tax, rent, depreciation on equipment, and salaries.
Variable Costing
Product costs under variable costing include direct material, direct labor, and variable manufacturing overhead. Product costs under absorption costing keep fixed manufacturing overhead to calculate the profitability of the product
Under variable costing, however, the fixed manufacturing overhead is expensed, thus not affecting the product's profitability.
To check whether the product is profitable, all the components, such as direct material, direct labor, fixed manufacturing overhead, and variable manufacturing overhead, should be considered.
Inventoriable costs Components
The components that formulate the product costs are direct material, direct labor, and manufacturing overhead. Manufacturing overhead consists of indirect material and indirect labor.
- Direct material: These materials can be effectively associated with a cost item and are priced per unit produced.
- Direct labor: This pertains directly to supply chain workers who participate in producing goods or performing tasks or services and who are easily ascribable to a task, process, or production unit.
- Manufacturing overhead: It is further categorized as:
- Indirect material: The costs associated with sustaining and operating a business are included in indirect costs, which go beyond the expenditures you incur when manufacturing a product.
- Indirect labor: Any employee whose work is not necessary to create a good is said to be engaged in indirect labor.
How to Calculate Production Unit Cost
To calculate, check out the formula below:
Inventoriable Costs = Total Direct Materials + Total Direct Labor + Manufacturing Overhead
Manufacturing Overhead = Indirect Materials + Indirect Labor
Inventoriable Cost Per Unit = (Total Direct Materials + Total Direct Labor + Manufacturing Overhead) / Total Number Of Units
Absorption Cost Total = Direct Material + Direct Labor + Fixed Manufacturing Overhead + Variable Manufacturing Overhead
Variable Cost Total = Direct Material + Direct Labor + Variable Manufacturing Overhead
Variable manufacturing overhead includes costs that change with a change in production levels. For example, material handling wages, equipment utilities, and supplies for production.
Fixed manufacturing overheads are costs that remain constant regardless of changes in production. Examples include rent and production supervisory salaries.
Formulas for product costing under the absorption and variable costing techniques differ because they treat fixed manufacturing overhead.
Example of Inventoriable Costs
Let's take some examples to understand the calculation.
Example 1
A toy manufacturing company has the following costs for the month:
- Direct material costs = $1,000
- Direct labor costs = $1,500
- Manufacturing overhead costs = $1,100
100 toys were produced and sold.
The Total Cost Of Production = Direct Material Costs + Direct Labor Costs + Manufacturing Overhead Costs
= $1,000 + $1,500 + $1,100
= $3,600
The Total Cost Of Production Per Unit = Total Cost Of Production / Total Number Of Units
= $3,600 / 100
= $36
Example 2
A beer manufacturing company has the following costs for the month:
1000 units were produced and sold
- Direct material costs = $2,000
- Direct labor costs = $1,500
- Marketing costs = $500
- SG&A = $700
- Rent = $500
- Salaries = $800
Total Cost Of Production = Direct Material Costs + Direct Labor Costs + Rent + Salaries
= $2,000 + $1,500 + $500 + $800
= $4,800
The Total Cost Of Production Per Unit = Total Cost Of Production / Total Number Of Units
= $4,800 / 1000
= $4.8
Note marketing, selling, general, and administrative costs are not included in the calculation.
Inventoriable Costs FAQs
Inventoriable Costs = Direct Material + Direct Labor + Manufacturing Overhead.
Selling, general, and administrative expenses are not included in the calculation of production costs because they are included in the expenses section of the income statement.
They are a period expense and are not assigned to the product.
The main difference between production costs and manufacturing costs is that production costs mirror all the expenses necessary to conduct a business.
On the other hand, manufacturing costs only include expenses that are necessary for manufacturing a specific product.
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