Under both the perpetual and periodic inventory systems, when does the cost of inventory become an expense (Cost of Goods Sold) on the income statement?

• A. When payment is made to the supplier
• B. When the inventory is purchased
• C. At the end of the accounting period
• D. When the inventory is sold

Answer: (D)

Verified step by step guidance

1. Understand the concept of Cost of Goods Sold (COGS): COGS represents the direct costs attributable to the production of goods sold by a company. It includes the cost of materials and labor directly used to create the product.
2. Recognize the difference between perpetual and periodic inventory systems: In a perpetual inventory system, inventory records are updated continuously as transactions occur. In a periodic inventory system, inventory records are updated at the end of an accounting period.
3. Identify when inventory becomes an expense: Inventory is initially recorded as an asset on the balance sheet. It becomes an expense (COGS) on the income statement when the inventory is sold, as this reflects the matching principle in accounting, which matches expenses to revenues.
4. Clarify why payment to the supplier or purchase of inventory does not trigger COGS: Payment to the supplier or purchase of inventory only affects the balance sheet (e.g., cash or accounts payable and inventory accounts). These actions do not directly impact the income statement until the inventory is sold.
5. Conclude that under both inventory systems, the cost of inventory becomes an expense (COGS) on the income statement when the inventory is sold, as this aligns with the revenue recognition principle and the matching principle in accounting.