Question

Assuming Dobbins decided to charge barrel costs (but not other warehousing and aging costs) to inventory, what 1988 income statement and balance sheet items would change, and what would the new amounts be? (Assume no change to in-process inventory.) If Dobbin's suggestion of including all warehousing and aging costs in inventory were accepted, how would the 1988 financial statements change?

Answer 1

Before we move to understand the answer to this question, we need an overview of Direct and Indirect cost. Direct cost directly affects the service/goods cost you serve/sell. It decreased your Gross profit as the Cost of goods/inventory increases. This cost directly affects to production. Indirect cost is operational cost like Rent, Salaries and other over heads. These costs affects your net profit.

In this question If the barrel cost is charged to Inventory the cost of Inventory would go up by that amount as a result of that the Cost of goods sold and the cost of closing stock of inventory would increase. This would change the amount of Gross Profit.

As the cost of barrel is charged to Inventory, this cost would no more be shown on the operational expenses. This change will not affect the over-all Net profit because the only change on the income expense is moving the cost from Operational expense to Production expense.

Further moving to the Balance sheet the value of Closing stock/Inventory would increase by the amount of cost of barrel that's charged to Inventory.

The same treatment would be applied in case of including all warehousing expense. However in the aging cost of inventory, the value of closing inventory will decrease.