Which of the following statements is TRUE?
A Classifying a cost as either direct or indirect depends upon the behavior of the cost in response to volume changes.
B Classifying a cost as either relevant or irrelevant depends upon whether the cost can be easily identified with the cost object.
C Classifying a cost as either product or period depends upon whether the cost is expensed in the period in which it is incurred.
D Classifying a cost as either fixed or variable depends upon whether an expenditure is avoidable or not in the future.
The correct answer and explanation is :
The correct statement is C: Classifying a cost as either product or period depends upon whether the cost is expensed in the period in which it is incurred.
Explanation:
Let’s break down each option to understand why C is the correct answer:
A. Classifying a cost as either direct or indirect depends upon the behavior of the cost in response to volume changes.
- This statement is incorrect. Direct and indirect costs are classified based on their relationship to the cost object (e.g., a product or department). Direct costs can be directly traced to a cost object, while indirect costs cannot. The behavior of the cost in response to volume changes is more relevant to classifying costs as fixed, variable, or semi-variable, not direct or indirect.
B. Classifying a cost as either relevant or irrelevant depends upon whether the cost can be easily identified with the cost object.
- This statement is incorrect. Relevant and irrelevant costs are classified based on their future impact on decisions. A relevant cost is one that will be incurred in the future and can be avoided depending on the decision at hand. An irrelevant cost is one that will not change regardless of the decision. The ability to easily identify a cost with a cost object is more related to direct versus indirect classification, not relevance.
C. Classifying a cost as either product or period depends upon whether the cost is expensed in the period in which it is incurred.
- This statement is true. Product costs are costs that are capitalized as inventory on the balance sheet and only expensed as cost of goods sold when the product is sold. These include direct materials, direct labor, and manufacturing overhead. Period costs, on the other hand, are expensed in the period they are incurred, such as selling, general, and administrative expenses. So, whether a cost is expensed immediately or capitalized as part of the product depends on whether it is a product cost or a period cost.
D. Classifying a cost as either fixed or variable depends upon whether an expenditure is avoidable or not in the future.
- This statement is incorrect. Fixed and variable costs are classified based on their behavior relative to production or sales volume. Fixed costs remain constant regardless of volume, while variable costs change in direct proportion to volume. Whether an expenditure is avoidable or not is more relevant to the concept of relevant and irrelevant costs, not fixed or variable.
In conclusion, statement C is the only true statement as it correctly explains how product and period costs are classified based on when they are expensed.