Question

If a company’s cost accounting system leans in the direction of including ambiguous costs as period costs rather than product costs, how will the company’s reported profits be affected during periods when the firm’s inventory of manufactured finished goods increases? Why?

Answer 1

Period costs are the costs which are charged to the income statement in the period in which it is incurred. Product costs are the cost which are associated with product and used for valuing the closing inventory.

When ambiguous costs are charged to income statement as period costs rather than treating as product costs the profit reported during the period will decrease. The reason being product costs will be lower and hence closing inventory will be valued at lower product cost resulting in lower inventory valuation. Closing Inventory valued at lower value reduces the profit for the period. The period costs are fully charged to income statement and hence this cost is not part of closing inventory costs and again this will lead to lower profits being reported.