AC300-Unit 3 Homework - C2-5 Cost and Expense Recognition...

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Unformatted text preview: C2-5 Cost and Expense Recognition (AICPA Adapted) 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. Required 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 this basis. C2-5 Cost and Expense Recognition An asterisk (*) will appear next to an incorrect amount(s) in the outlined cell(s). If you are still getting a red asterisk, and think the answer is correct, but used a formula in the cell try manually typing in the answer according to the rounding instructions. Required 1. Explain the rationale for recognizing costs as expenses at the time of product sale. Name: Recognition means the process of formally recording and reporting an item in the financial statements of a company. Revenues should be recognized when realization has taken place, and they have been earned. A company usually recognizes revenue at the time of sale because this is when realization occurs and its earning process is substantially complete. This would be same for recognizing costs as expenses at the time of product sale. Because this is when the actual sale takes place and the cost have been incurred it becomes an expense at the end of product sale. The realization of selling product is taking place and the cost to produce that product becomes an expense because that product is being disposed. 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. Costs are the part of company's expenses which are outflows of assets of a company or incurrences of liabilities during the period from delivering or producing goods, rendering services. The revenue derived from the sale of the product becomes an asset afterwards. Assets have been used to produce product which incurres a cost the revenue from this product becomes an asset again. 3. Some expenses are assigned to specific accounting periods on the basis of systematic and rational allocation of asset cost. Explain Explain the underlying rationale for recognizing expenses on this basis. Expenses recorded on the basis of systematic and rational allocation include depreciation of property and equipment and amortization of intangibles. Immediate recognition is appropriate for period cost those expenses related to a period of time, such as administrative salaries. The intent is to match the sacrifices against the benefits (i.e., the efforts against the accomplishments) in the appropriate accounting period. A company recognizes and matches expenses against revenues on the basis of three principles: association of cause and effect systematic and rational allocation immediate recognition C2-5 Cost and Expense Recognition An asterisk (*) will appear next to an incorrect amount(s) in the outlined cell(s). If you are still getting a red asterisk, and think the answer is correct, but used a formula in the cell try manually typing in the answer according to the rounding instructions. Required 1. Explain the rationale for recognizing costs as expenses at the time of product sale. Name: Solutions Some costs are recognized as expenses on the basis of a presumed direct association with specific revenue. This presumed direct association has been identified both as "associating cause and effect" and as the "matching concept." Direct cause-and-effect relationships can seldom be conclusively demonstrated, but many costs appear to be related to particular revenue, and recognizing them as expenses accompanies recognition of the revenue. Generally, the matching concept requires that the revenue recognized and the expenses incurred to produce the revenue be given concurrent periodic recognition in the accounting records. Only if effort is properly related to accomplishment will the results, called income, have useful significance concerning the efficient utilization of business resources. Thus, applying the matching principle is a recognition of the cause-and-effect relationship that exists between expense and revenue. Examples of expenses that are usually recognized by associating cause and effect are sales commissions, freight-out on merchandise sold, and cost of goods sold or services provided. 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. Some costs are assigned as expenses to the current accounting period because (a) their incurrence during the period provides no discernible future benefits; (b) they are measures of assets recorded in previous periods from which no future benefits are expected or can be discerned; (c) they must be incurred each accounting year, and no build-up of expected future benefits occurs; (d) by their nature they relate to current revenues even though they cannot be directly associated with any specific revenues; (e) the amount of cost to be deferred can be measured only in an arbitrary manner or great uncertainty exists regarding the realization of future benefits, or both; (f) uncertainty exists regarding whether allocating them to current and future periods will serve any useful purpose. Thus, many costs are called "period costs" and are treated as expenses in the period incurred because they have neither a direct relationship to revenue earned nor can their occurrence be directly shown to give rise to an asset. The application of this principle of expense recognition results in charging many costs to expense in the period in which they are paid or accrued for payment. Examples of costs treated as period expenses would include officers' salaries, advertising, research and development, and auditors' fees. 3. Some expenses are assigned to specific accounting periods on the basis of systematic and rational allocation of asset cost. Explain Explain the underlying rationale for recognizing expenses on this basis. In the absence of a direct basis for associating asset cost with revenue, and if the asset provides benefits for two or more accounting periods, its cost should be allocated to these periods (as an expense) in a systematic and rational manner. Thus, when it is impractical, or impossible, to find a close cause-and-effect relationship between revenue and cost, this relationship is often assumed to exist. Therefore, the asset cost is allocated to the accounting periods by some method. The allocation method used should appear reasonable to an unbiased observer and should be followed consistently from period to period. Examples of systematic and rational allocation of asset cost would include depreciation of fixed assets, amortization of certain intangibles, and allocation of rent and insurance. ...
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