Companies expend cash to purchase goods and services to help run their business operations. Accountants spend copious amounts of time classifying expenditures as costs or expenses. This presents an accurate picture of a company’s financial health. Generally accepted accounting principles also provide guidance on classifying costs. Failure to properly report costs may result in poor audit opinions and the possibility of the requirement to restate previous financial statements. Stakeholders do not typically prefer to see a company take these actions.
Review the documents relating to the cash expenditure.
Identify the item as a one-time expense or an item meant for future use.
Record a one-time expense as a period cost. These indicate the company has received the value for the cost. Report a cost meant for future use as an asset.
Differentiate costs relating to assets as current or long-term. Current assets do not last longer than 12 months. Long-term assets last more than 12 months.
Place future planned expenses in a prepaid account. For example, a cost may be the purchase of an insurance policy. Each subsequent month accountants will post an expense to recognize the use of this cost.
Record inventory costs in their respective account. Materials go to raw materials, supplies go to an overhead account, and goods ready to sell go in a finished goods inventory account.
Transfer inventory costs to cost of goods sold only when the company sells the item. Cost of goods sold “expenses” inventory costs on the income statement.