Expense recognition matching

ADS EXPENSE RECOGNITION: MATCHING. Expenses were defined earlier in the chapter as “outflows or other using up of assets or incurrences of liabilities. When are expenses recognized? In practice, expense recognition often matches revenues and expenses that arise from the same transactions or other events. There is a cause-and-effect relationship between revenue and expense recognition implicit in this approach. In a given period, revenue is recognized according to the realization principle, and the matching principle then requires that all expenses incurred in generating that revenue also be recognized. The net result is a measure—net income—that identifies the amount of profit or loss for theperiod provided by operations.

Although these concepts are straightforward, their implementation can be difficult, because many expenses are not incurred directly to produce a particular amount of revenue. Instead, the association between revenue and many expenses is indirect. Therefore, expense recognition is implemented by one of four different approaches, depending on the nature of the specific expense:
 
 Based on an exact cause-and-effect relationship.
This approach is appropriate for cost of goods sold, as one example. There is a definite cause-and-effect relationship between Dell Inc. ’s revenue from the sale of personal computers and the costs to produce those computers. Commissions paid to salespersons for obtaining revenues also isan example of an expense recognized based on this approach.

By associating an expense with the revenues recognized in a specific time period.
Many expenses can be related only to periods of time during which revenue is earned. For example, the monthly salary paid to an office worker is not directly related to any specific revenue event. Instead, the employee provides benefits to the company for that one month that indirectly relate to the revenue recognized in that same period.

By a systematic and rational allocation to specific time periods.
Some costs are incurred to acquire assets that provide benefits to the company for more than one reporting period, so we recognize expenses over those time periods. For example, straight-line depreciation is a “systematical and rational” way to allocate the cost of equipment to the periods in which that equipment is used to produce revenue.

In the period incurred, without regard to related revenues.
Sometimes costs are incurred, but it is impossible to determine in which period or periods, if any, related revenues will occur. For example, let’s say Google spends $1 million for a series of television commercials. It’s difficult to determine when, how much, or even whether additional revenues occur as a result of that particular series of ads. As a resulT.The timing of expense recognition also affects the timing of asset and liability recognition and de-recognition.

When we debit an expense, the corresponding credit usually either decreases an asset (for example, decreasing cash because it was used to pay an employee’s salary) or increases a liability (for example, increasing salaries payable to accrue wages that will be paid at a later date). ADS