Ever wonder what magic goes on behind the accountant’s desk that turns your shoe box of invoices and receipts into an income statement? It is not magic at all. Rather, it is a thorough process that can be broken up into four steps.
STEP 1: CLASSIFYING ACCOUNTS
All your invoices and receipts sent in must be classified as either income, expense, asset, or liability. Then those accounts, especially the expenses, need to be further classified. The main categorizations for expenses are product costs and period costs.
- Product costs are expenses which are incurred directly from producing the product or performing the service.,
- Period costs cannot be directly tied to a specific product or service, but are incurred from operating your business each year.
For example, let’s say you are running a business that makes and sells Panda Toys in Hong Kong. The product costs for this toy would be the materials used for production, the labor used to produce the toy, and other costs in the manufacturing process. Meanwhile, the period costs would be things like, rent, advertisement, entertainment, and administrative expenses, which cannot be assessed to a particular toy.
On the income statement, product costs are often termed as cost of goods sold (COGS), and period costs are sometimes called selling, general, and administrative expenses (SG&A), or operating expenses. After this extensive classification, all the invoices are organized into chronological order by month.
You may also be interested in these other blog articles: