Accounting theory discussion on expense

1. LECTURE 10
EXPENSES
ARTHIK DAVIANTI, SE. MSI. AK. CA.

2. EXPENSES DEFINED
Expenses are decreases in economic benefits
during the accounting period in the form of
outflows or depletions of assets or
incurrences of liabilities that result in
decreases in equity, other than those
relating to distributions to equity
participants
(Framework para.70)

3. EXPENSES DEFINED
The decrease in value pertains eventually to
the outflow of cash
Expenses encompass losses as well as
expenses which arise in the course of
ordinary activities
The distinction between abnormal and
extraordinary items is no longer permitted

4. To make a definition of expenses
operational, it must be associated with a
physical activity of the entity - something it
does
production and sales generate revenue and
the using up of goods and services in
support of those functions causes
expenses to occur
EXPENSES DEFINED

5. CHANGES IN ASSETS AND
LIABILITIES
Expenses represent a value change
Framework definition of expenses refers to
outflows or depletions of assets or
incurrence of liabilities
Framework makes no reference to the
relationship of expenses to revenue

6. EXPENSES AND ‘COSTS’
Sometimes an expense is referred to as an
‘expired cost’
The using up of assets entails a cost -
expense - to the entity
If there is no cost to the firm there is no
expense
Later … The recognition criteria for
expenses are consistent with those of the
other accounting elements

7. EXPENSE RECOGNITION
An expense is recognised if
 it is probable that any future economic
benefit associated with the item will flow
to or from the entity; and
 the item has a cost or value that can be
measured with reliability
 prudence and neutrality
 freedom from material error and bias,
represent faithfully

8. EXPENSE RECOGNITION
The decrease in future economic benefits
relates to a decrease in an asset or an
increase in a liability
 recognition of an expense occurs
simultaneously with the recognition of an
increase in a liability or a decrease in assets

9. EXPENSE MEASUREMENT
In measuring expenses a number of
decisions have to be made as to how
expenses should be allocated over periods
of resultant revenue
 accrual accounting
 matching expenses against revenues in
the period to which they relate

10. ALLOCATION OF EXPENSES
Revenue = accomplishment
Expenses = effort
For any given period, matching revenue and
expenses yields net accomplishment
(periodic profit)
Most of the problems of profit determination
have to do with expense allocation and
matching

11. ALLOCATION OF EXPENSES
The accountant must decide
 whether a cost pertains to future revenues
and therefore should be deferred
 whether a cost pertains to current
revenues and therefore should be written-
off against that revenue in the current
period
 whether a cost, although incurred and not
yet paid, is related to current revenue and
therefore should be accrued

12. The matching process involves the
simultaneous or combined recognition of
revenues and expenses that result directly
and jointly from the same transactions or
other events
 sales and cost of goods sold
ALLOCATION OF EXPENSES

13. ALLOCATION OF EXPENSES
In practice, matching is
 very difficult to do
 involves a great deal of judgement
 arbitrary

14. Three basic methods of matching
 associating cause and effect
 systematic and rational allocation
 immediate recognition
ALLOCATION OF EXPENSES

15. ASSOCIATING CAUSE AND
EFFECT
The ideal way of matching is by associating
cause with effect
Cause and effect relationships are very
difficult to prove
 reasonable observation

16. SYSTEMATIC AND RATIONAL
ALLOCATION
An alternative is to use a systematic and
rational allocation procedure
 associate expenses to segments of time
 the expense is assumed to correlate
with the revenue for that period
depreciation
Requires estimates and assumptions which
are usually arbitrary

17. IMMEDIATE RECOGNITION
Used if neither of the previous two can be
used
Recognise the outlay immediately as an
expense
 advertising expenses
 research expenditure
 impairment expenses

18. CRITICISMS OF ALLOCATIONS
The doctrine of conservatism means that
expenses, losses and liabilities are
recognised as soon possible, even if evidence
for them is weak
The asymmetrical treatment of revenue and
expenses may create a conservative bias and
misleading financial statements
Personal incentives may influence managers’
judgement in the allocations process

19. The allocations (matching) process is an
essential part of accounting practice
The process has made the balance sheet
secondary to the income statement
The balance sheet has become a repository
for unexpired costs
Most of what accountants put in accounting
reports is ‘rubbish’
CRITICISMS OF ALLOCATIONS

20. The allocation problem
Thomas (1975) – allocations in accounting
do not meet the following criteria
 additivity
 unambiguity
 defensibility
CRITICISMS OF ALLOCATIONS

21. Allocations are defended by accountants on
two grounds
 a given input provides services in the
current and future periods and the cost
allocation pattern reflects the cost of the
services received in the given periods
 allocated data serves a useful purpose
because readers of accounting reports,
which include allocated data, find them
useful
CRITICISMS OF ALLOCATIONS

22. But, allocations are ‘incorrigible’ (bad beyond
correction) – Thomas (1975)
 they are not capable of verification or refutation
by objective, empirical means
 the patterns of allocation do not exist in the
real-world; they exist only in the minds of
accountants
 an input’s individual contribution to the output
cannot be known because all the inputs interact
with each other to generate an output
 empirical studies do not demonstrate that
allocations are useful
CRITICISMS OF ALLOCATIONS

23. Alternative approaches suggested
 exit price accounting
no allocations
CRITICISMS OF ALLOCATIONS

24. DEFENCE OF ALLOCATIONS
Change the objective of allocations
Continue with allocations only if the benefits
outweigh the costs of doing so

25. CHALLENGES FOR ACCOUNTING
STANDARD SETTERS
The IASB is aware of the allocations problem
and is tackling it in its current projects
The plea is for reasonableness or
appropriateness and not for objective
evidence
 contradicts the recognition of revenue
 conservatism

26. ISSUES FOR AUDITORS
Auditors face issues surrounding the
distinction between expenses and assets,
the period in which expenses are
recognised, and appropriate measurement
of expenses
 concepts such as matching and
conservatism are not helpful if they distort
information and reduce its utility
 managers have incentives to distort
expenses
 big bath and cookie jar accounting
26

27. SOURCE:
GODFREY, HODGSON, HOLMES, AND TARCA (2012)
ACCOUNTING THEORY 7TH EDITION
IAI (2015) STANDAR AKUNTANSI KEUANGAN
PER EFEKTIV 1 JANUARI 2015