Which of the following best determines the difference between a product cost and a period cost in financial accounting?

• A. Whether the cost is directly associated with the production or acquisition of inventory
• B. Whether the cost is paid in cash or on credit
• C. Whether the cost is incurred in the current or previous accounting period
• D. Whether the cost is variable or fixed

Answer: (A)

Verified step by step guidance

1. Understand the definitions of product cost and period cost: Product costs are directly associated with the production or acquisition of inventory, such as direct materials, direct labor, and manufacturing overhead. Period costs, on the other hand, are not tied to inventory production and include expenses like selling, administrative, and general expenses.
2. Analyze the options provided in the question: The correct distinction between product and period costs is based on whether the cost is directly associated with the production or acquisition of inventory. This is the key concept in financial accounting.
3. Eliminate irrelevant options: For example, whether the cost is paid in cash or on credit does not determine whether it is a product or period cost. Similarly, whether the cost is incurred in the current or previous accounting period is unrelated to this distinction. Lastly, whether the cost is variable or fixed does not define whether it is a product or period cost.
4. Focus on the correct option: The correct answer is the one that emphasizes the association of the cost with inventory production or acquisition. This is the fundamental difference between product and period costs.
5. Conclude with the importance of understanding this distinction: Knowing the difference between product and period costs is essential for accurate financial reporting and decision-making, as product costs are capitalized as inventory and expensed when sold, while period costs are expensed in the period incurred.