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Criteria for determining when costs are expenses

An accountant must be familiar with the concepts involved in determining earnings of a business entity. The amount of earnings reported for a business entity 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.

Instructions

(a) Explain the rationale for recognizing costs as expenses at the time of product sale.
(b) What is the rationale underlying the appropriateness of treating costs as expenses of a period instead
of assigning the costs to an asset? Explain.
(c) In what general circumstances would it be appropriate to treat a cost as an asset instead of as an
expense? Explain.
(d) 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 of
systematic and rational allocation of asset cost.
(e) Identify the conditions under which it would be appropriate to treat a cost as a loss.
(AICPA adapted)

Solution Preview

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

This is based on the matching concept. When revenues are recognized at the time of sale, the costs incurred in generating the revenues should also be recognized at the same time so that proper matching takes place and the net income correctly reports the difference between the revenues and the costs incurred in generating the revenues. For example cost of goods sold is recorded at the same time when sale is recorded. Prior to this the cost of goods is shown in inventory. When we record the revenue at the same time we should record the cost of the goods which are sold so as to match correctly the revenue and expense.

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

Solution Summary

The solution explains the concepts and criteria for determining when costs are expenses

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