Question

CA2-6 (Expense Recognition Principle) 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 revenues and expenses 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.

Answer 1

Solution-a

The specisifed revenue is base of direct association. Example - Cost of goods sold and sales commission.

Solution-b

The period costs is best example for the same because this costs don't have direct relation with the earned revenue and also not associated with rise to an asset. Example- R & D, Slaries office and Adveritising.

Solution-c

If there is expectation that the assets will give benefits in future, but the cost provides result in acquiring of an assets for the service potential of the future. Example- At the end of accounting period costs of merchandise on hand.

Solution-d

If there is absentisem of direct basis which is associated with assets cost with revenue and if the assets provide more benefits for 2 or more than 2 accounting periods.

Example- Depreciation of fixed assets.

Solution-e

If company not able to generate any revenue and cost is treated as loss.