D describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis;

Question 1

Cash based FS’s recognized as

Answer 1

Expenses incurred, revenues recieved. No particular recognition

Cash paid = expense
Cash received = revenue

Question 2

Accrual expense recognition (matching principle)

Answer 2

Revenue generating expenses are matched in the period as sales of goods or service, not the purchase. Ex: Inventory

Non-Rev generating exps ‘Period Costs’(Ex: SG&A): Match in the period that expenses are incurred.

Question 3

Inventory Expense Recognition

‘inventory expenses’ = COGS

Answer 3

FIFO: COGS = First purchases, E.I. = Last purchases
Ex: food (limited shelf life)

LIFO: COGS = Last purchases, E.I. = first purchases
Ex: Coal ( Inventory that doesn’t deteriorate w/ age)
Only US GAAP. Tax benefits: Inflation = higher COGS = lower taxable income = lower income taxes

WAC: COGS: $COGAS$/units, EI = COGAS-SOLD (WAC) *WAC lies between FIFO and LIFO *No physical flow of inventory *Easy to use

Question 4

Depreciation Expense Recognition (matching long lived asset costs w/ revenue)

Depreciation = Tangible
Deplection = Natural Resources
Amortization = Intangibles

Answer 4

General asset Depr. Rule: Most assets yield most benefits early on than later on

SL = Cost - Residual value / Useful life. (Lower Depr. exp @ beg = higher NI at beg.)

Accl Depr: Total depr. Exp = SL except, accelerated depreciation recognizes depreciation earlier than later which inc. Depr exp. early, decreases NI early

DB Method: Constant rate of depr. to an assets decl. book value each year ‘ Diminishing balance method’
Most common:DDB: 2x straight line. Convert to SL if asset has no residual value. No explicit asset residual value use. Depr. ends once est. res. value is reached.

Question 5

Amortization (SL if finite life ex: franchise agreement)

Answer 5

Indefinite life = goodwill. Impairment. Recognize impairment on NI when incurred.

Question 6

BDE n Warranty Expense

Answer 6

BDE: When firms sells goods or services on credit
Warranty expense: Firm provides a warranty
Matching principle: Recognize the expense in the period of the sale. (Ex: Rec. each time we sell a toaster - record as Ex, L on THAT date. When toaster comes in for warranty service we reduce liability

Warranties: Est. as Exp. Show as L
When warranty is serviced, Warranty L is reduced and

Question 7

Financial Analysis Implications for expense recognition

Answer 7

Firms delay or accelerate expense recognition

Aggressive: Delay recognition: Inc. NI
Conservative: Accelerate depreciation recognition: Dec. NI

Question 8

Lacey on DACCTS n WARR

Answer 8

lkjhg