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