How are expenses recognized and measured?

EXPENSE RECOGNITION AND MEASUREMENT

TIMING OF EXPENSE RECOGNITION

Assets provide future benefits, and expenses measure the consumption of those benefits. Timing of expense recognition focuses on when the firm consumes the benefits. The critical question is, "When does the firm consume the benefits of an asset?" That is, when does the asset leave the balance sheet and become an expense on the income statement?

CRITERIA FOR EXPENSE RECOGNITION

The firm recognizes an expense when either of the following conditions holds.

1 . The consumption of the asset results from a transaction that leads to the recognition of revenue. The consumption of the benefit embodied in the asset is an expense in the period when the firm recognizes revenue. For example, a sale of merchandise that results in the seller's recognizing revenue consumes the benefits of the inventory asset and results in an increase in the expense called Cost of Goods Sold. The amount of this expense is determined by the product costs associated with the inventory. This treatment, the matching convention, matches the timing of some expenses with revenue recognition.

2 . The consumption of the asset results from the passage of time. When the firm consumes the benefits of an asset over time, that cost becomes an expense of the period when the firm consumes the benefits. For example, the firm consumes benefits of this month's rent on the warehouse during the current month. Therefore, the firm reports the cost as part of this month's expenses (that is, period expenses). Most administrative expenditures are period expenses. Another period expense, results from the expenditures on advertising and research, which the firm must recognize as expense in the period of expenditure, regardless of the firm's expectation of future benefits.