In external reporting, costs are typically classified into two main categories: inventoriable costs and period costs. Inventoriable costs are expenses that are tied directly to the production of goods, such as raw materials and direct labor. These costs are capitalized as part of the inventory on the balance sheet until the goods are sold. Once sold, these costs are recognized as an expense (cost of goods sold) on the income statement.
On the other hand, period costs are not directly tied to the production process and are expensed in the period they are incurred. These include selling, general, and administrative expenses. Unlike inventoriable costs, period costs are reported on the income statement immediately, impacting the net income of the company without being linked to inventory levels.
Another aspect of costs in external reporting is that they may reflect current values; however, in practice, costs are often recorded based on historical data. While it is true that there are no strict rules regarding how to report these costs, organizations generally follow accepted accounting principles to maintain consistency and transparency in their financial statements.
Costs also encompass various amounts associated with operating a business, which provides important insights to investors and creditors. Understanding how costs are classified and reported is essential for stakeholders to make informed decisions about a company’s financial health.