Which of the following costs are expensed in the period in which they are incurred? a. direct materials costs b. factory overhead costs c. nonproduction costs d. product costs
The correct answer and explanation is:
Correct Answer: c. nonproduction costs
Explanation:
Nonproduction costs are expensed in the period in which they are incurred because they are not directly tied to the manufacturing of a product. These costs are often referred to as period costs in accounting. Examples include selling, general, and administrative expenses (SG&A), such as advertising, salaries of office staff, rent for corporate offices, and utilities unrelated to production.
In contrast, product costs—which include direct materials, direct labor, and factory overhead—are capitalized as inventory on the balance sheet. These costs are not expensed immediately. Instead, they remain as part of the cost of inventory and are only expensed when the inventory is sold, at which point they become part of cost of goods sold (COGS) on the income statement.
Here’s a breakdown:
- Direct materials costs (a): These are capitalized as part of inventory and expensed when the product is sold.
- Factory overhead costs (b): These are also part of product costs and follow the same treatment—capitalized and then expensed as part of COGS.
- Product costs (d): This is a broad term that includes both direct materials, direct labor, and factory overhead. All are expensed only when the product is sold, not when incurred.
Nonproduction costs (c) differ because they are not related to the actual manufacturing process. Since these costs do not add value to inventory, they must be expensed in the accounting period they occur. This aligns with the matching principle in accounting, which states that expenses should be matched with the revenues they help generate. Nonproduction costs do not directly generate revenue through inventory sales, so they are not deferred but immediately recognized on the income statement.