This is essentially a matching problem. The cost expended to produce revenues should be matched with the revenues produced in any given period.

Some situations are easy, like commissions. A commission is earned when the product is sold, so it should be a reduction to arrive at net income. In other words, it is a period cost or expense.

Inventory, when it is manufactured or acquired is parked on the balance sheet as an asset because it has not yet generated any income. When it is sold, hopefully for more than it cost to produce, it is removed from the balance sheet and expensed. This is why you will sometimes see sales with names like "Inventory Clearance - Our Accountant is making us do it to reduce our taxes." Every dollar of inventory sold is a dollar less income, which reduces the tax burden.

Other things are a little more difficult to determine when they result in the generation of revenue. You buy a machine to, I don't know, make T Shirts. The only reason you bought it is because you believe it is the best way for you to acquire the T Shirts for sale to your customers. At a profit. So, the machine is going to be around forever, or at least a very long time. The cost of the machine should be allocated to the periods in which revenues are generated from its use. Say ten years. Therefore, generally speaking, only about 1/10th of the cost of the plant should show up in the income statement every year.

The way this is done is to record the machine as an asset and depreciate it over time to the income statement. There are several methods which attempt to best match this cost to the revenue generation. Generally, these are as follows:

If the machine is good for 200,000 T shirts. If it cost $500,000, then you could depreciate it based on the units produced, at a rate of $2.5o per units ($500,000/ 200,000 = $2.50). This is the so-called units-of production method.

The machine has no stated life in units of production, but is more useful in the early years than the later ones, in other words, it becomes less efficient as time goes bye, you can use an accelerated method, which puts more costs in the early years than in the later ones. There are several methods for this and you can look them up, so I won't go into it here.

The machine will not become less efficient over time. Therefore, you pick a "useful life" based on experience or discussion and evenly spread the cost of the number of years the machine will be useful.

So far,

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