Specific expense recognition application

Inventory expense recognition: identify the cost of inventories sold in the accounting period

  • Specific identification method (24)
    • If the firm can identify exactly which items were sold, which remains in inventory → easy to identify
  • First-in, first-out method (25)
    •  First item to purchase is assumed to be the first item to sell.
    • Cost of inventory acquired first is used to calculate the cost of goods sold for the period
  • Last-in, first-out method (26)
    • Last purchase will be first sold 
    • Cost of most recently purchased inventory = cost of the inventory for the whole period 
  • Weighted average cost method (27)
    • cost of the inventory for the whole period = cost of available goods/total unit available

Depreciation Expense Recognition

  • Depreciation (28): Allocation of cost over asset’s life 
    • Depletion (28-1): applied to natural resource
    • Amortization (28-2): Intangible assets
  • Straight-line (SL) depreciation (29)
    • Recognize equal amount of depreciation each period
  • Accelerated depreciation method (30)
    • Used for assumption: Asset generate more revenue at its early life 
    • Matching revenue and expenses
    • Systematic way to recognize more depreciation expense in the early years of asset’s life
    • Declining balance method (DB (31):
      • Constant rate of depreciation to an asset’s (declining) book value
      • Double-declining balance (DDB) (32): most common declining balance method
        • Applies 2 times straight-line rate to declining balance
  • Comparison between straight-line method and accelerated depreciation method
    • Earlier year: straight-line method results in lower expense, greater net income
    • Later year: reverse

Amortization expense Recognition

  • Amortization
    • Allocation of the cost of an intangible asset over its useful life (franchise agreement)
    • Amortization expense should match asset’s economic benefits during period
    • Most firms use SL amortization
    • Intangible assets with indefinite lives are not amortized: 
      • Must be tested for impairment annually
      • Expense = impairment amount is recognized in the income statement

Bad debt expense and Warranty Expense Recognition 

  • Matching principle requires the firm to estimate bad debt expense and/or warranty expense