An accountant must be familiar with the concepts involved in determining earning

Question

An accountant must be familiar with the concepts involved in determining earnings of a company. The amount of earnings reported for a company is dependent on the proper recognition, in general, of revenue and expense for a given time period. In some situations costs are recognized as expenses at the time of product sale; in other situations guidelines have been developed for recognizing costs as expenses or losses by other criteria.

1) Explain the rationale for recognizing costs as expenses at the time of product sale.

2) What is the rationale underlying the appropriateness of treating costs as expenses of a period instead of assigning the costs to an asset? Explain.

3) Some expenses are assigned to specific accounting periods on the basis of systematic and rational allocation of asset cost. Explain the underlying rationale for recognizing expenses on the basis.

Explanation / Answer

1) Matching Cost against Revenue principles stipulate that a revenue generated must have an associated cost to it. As & when a revenue is
recognized, so does the cost.

2) A cost might be incurred specific for the period and can't be put to assets because its purpose ends at the time of the spend. Some however needs to be accumulated in an asset account because its purpose hasn't ends. A raw material purchase for processing is not period cost but rather an asset, same thing for a merchandise inventory. It will only become an expense when it;s sold.

3) Cost for which you have enjoy the benefits of/ have incurred because the purpose of it have been exercised have to be recognized in the same period. For example, if you paid a rental for the office building in Jan for a period of 1 year. At the end of the January, 1/12 portion of the cost needs to be charged in Jan because you have enjoyed the space provided/ the rental for Jan have expired.

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