Definition: A cost is an expenditure required to produce or sell a product or get an asset ready for normal use. In other words, it’s the amount paid to manufacture a product, purchase inventory, sell merchandise, or get equipment ready to use in a business process.
What Does Cost Mean?
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There are many different costs, including fixed and variable, but they are all accounted for in the same way. Costs are recorded as expenses on the income statement during and accounting period and cleared out in a closing entry at the end of the period.
Example
Each cost is recorded in a different expense account depending on its purpose and cost driver. For example, the cost recorded to purchase inventory is booked in the cost of goods sold account when inventory is sold. These expenses are presented in a section of the income statement separate from the operating expenses. Cost of goods sold is used to compute gross margin and the gross margin ratio.
Costs incurred sell products like employing sales staff, renting selling space, and purchasing display ranks for products are recorded as selling expenses and presented on a multi-step income statement.
These two examples consist of cash outlays relating to purchase and selling inventory, but some businesses make their own inventory. Manufacturers invest large amounts of money in equipment and machines needed to produce and assemble products.
These machines are recorded on the balance sheet for the amount of money the business paid for them plus any expenses required to put them into service. In other words, the full cost of a piece of equipment is the purchase price, including taxes and fees, shipping and moving expenses, alterations, and any other expenses required to make the machine usable to the company. This cost is often referred to as the historical cost. Each piece of equipment is recorded this way on the balance sheet.
