Cost is the expenditure required to create and sell products and services, or to acquire assets. When sold or consumed, a cost is charged to expense. In the case of an asset, the charge to expense could be significantly deferred. The cost concept underlies the transition of assets from the balance sheet to expenses in the income statement.
When a cost is designated as an expense, it can be assigned to a wide range of possible expenses, such as:
- Cost of goods sold
- Selling expenses
- General and administrative expenses
- Extraordinary items
- Financing costs
Thus, the nature of a cost drives the type of expense to which it is eventually assigned.
For analysis purposes, a cost may also be designated as a variable cost, which varies with the level of activity. For example, the telephone cost tends to vary with the number of employees. A cost can instead be designated as a fixed cost, which means that it does not vary with changes in the level of activity. For example, the lease of a building will not vary, irrespective of the revenues of a business housed within that facility.