When do product costs become expenses? When the product is
a. purchased.
b. manufactured.
c. inventoried.
d. sold.
The correct answer and explanation is :
The correct answer is:
d. sold.
Explanation:
Product costs become expenses when the product is sold because of the matching principle in accounting. The matching principle states that expenses should be recorded in the same period as the revenues they help generate. Product costs include direct materials, direct labor, and manufacturing overhead, all of which are initially recorded as inventory on the balance sheet.
Until a product is sold, its cost is considered an asset (inventory) because it has future economic value. When the product is sold, the cost is transferred from inventory to Cost of Goods Sold (COGS) on the income statement. This is when the cost becomes an expense.
Here’s a breakdown of the process:
- Manufacturing Stage – Costs are accumulated as part of inventory (not yet an expense).
- Inventory Stage – The product is stored and held for sale (still an asset).
- Sales Stage – When the product is sold, its cost moves from inventory to COGS, appearing as an expense on the income statement.
For example, if a company manufactures a product for $50 and sells it for $100, before the sale, the $50 is recorded as inventory. Once sold, the $50 moves to COGS, and the company recognizes a profit of $50 ($100 revenue – $50 COGS).
This approach ensures accurate financial reporting and compliance with Generally Accepted Accounting Principles (GAAP).
