Inventoriable Costs
Inventoriable costs, also known as product costs, are all the costs that are used to create an inventory item in a company. These costs stay with the product as an asset (as inventory on the balance sheet) until the product is sold, at which point they are recognized as an expense (as cost of goods sold on the income statement).
Inventoriable costs typically include the following:
- Direct materials: These are the raw materials that go directly into producing the product. For example, in the case of a car manufacturer, direct materials would include steel, rubber, glass, etc.
- Direct labor: This is the cost of the labor directly involved in the production of goods. For example, in a factory, this would be the wages of the workers who are physically making the product.
- Manufacturing overhead: These are all the other costs associated with the production process that cannot be directly tied to a specific unit of product. This can include costs such as factory rent, utilities, depreciation on manufacturing equipment, and indirect materials or labor.
All of these costs are added together to calculate the cost of each unit of inventory. When inventory is sold, these inventoriable costs are then deducted from sales revenue to calculate gross profit.
It’s worth noting that inventoriable costs are distinguished from period costs, such as selling, general, and administrative expenses, which are not included in the cost of inventory and are expensed in the period they are incurred.
Example of Inventoriable Costs
Imagine you run a company that manufactures wooden chairs. Let’s break down the different types of inventoriable costs you would incur:
- Direct Materials: The primary direct material in this case would be the wood used to create each chair. If each chair requires $10 worth of wood, then this is the direct material cost per chair.
- Direct Labor: Let’s say you pay your carpenters $20 per hour and each chair takes one hour to build. That means your direct labor cost per chair is $20.
- Manufacturing Overhead: These would include costs like the depreciation on your woodworking tools, the rent for your factory, utilities, and the cost of indirect labor such as maintenance and cleaning staff. To keep things simple, let’s say all these costs add up to $5000 per month, and you produce 1000 chairs per month. That means your manufacturing overhead cost is $5 per chair.
So the total inventoriable cost per chair is: $10 (Direct Material) + $20 (Direct Labor) + $5 (Manufacturing Overhead) = $35 per chair.
This cost will be held as inventory on your balance sheet until the chair is sold. When you sell the chair, the $35 is moved to the cost of goods sold on your income statement, which is then subtracted from your sales revenue to calculate your gross profit.
Note: This is a simplified example. In the real world, allocating manufacturing overhead to individual products can be a complex process that involves many assumptions and calculations. Furthermore, some costs can be a mix of direct and indirect (like electricity used in production, for instance), and it requires careful accounting to properly allocate these costs.
