I think it is important to remember the difference between a product cost and a period cost. A product cost is associated with manufacturing a product (direct and indirect costs) that flows through inventory and to cost of goods sold on the income statement when the inventory is sold.

Period costs are selling, general and administrative expenses incurred by the business and are expensed when the cost are incurred. These costs are shown as operating expenses on the income statement.

Correct reporting of these costs are important as many investors look at a companys gross profit or gross profit percentage to determine the value of the company.

Net sales revenue X,XXX

Cost of goods sold X,XXX

Gross profit X,XXX

Gross profit % = Gross Profit/Sales

If cost were incorrectly classified as period costs versus product cost, net income would not change but gross profit would be higher than if the allocation were correct.

Do you think this cost classification is important? How might you see a problem if you were auditing the companys financial statements?