SUMMARY

ACCOUNTING THEORY
(SUBJECT CODE: ECAU601401)
Collaboration Learning
Chapter 10
EXPENSE
(Godfrey et.al. Accounting Theory 7th Ed)
Lecturer:
Mrs. Siti Nuryanah, S.E., M.S.M., M.Bus.Acc., Ph.D.

Group Member
1. Eggie Auliya Husna 1706105246
2. Fendhi Birowo 1706105290
3. Yolanda Tamara 1406612275

SALEMBA EXTENSION CLASS

ACCOUNTING PROGRAM
FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITY OF INDONESIA
YEAR 2018
1. What is expense?
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 Paragraph 70)

2. What are the differences among cost, expense and loss?

Cost is cash or cash equivalent price of obtaining an asset and bringing it to the location and
condition necessary for its intended use.
Expenses are referred as expired cost or using up of goods and services in support of those
functions causes to occur.
Losses are the differences between selling price and book value of an asset in which selling
price is lower that book value of an asset. Losses may or may not arise in the course of ordinary
activities of the entity.

3. When should expense be recognized?

Expense should be recognized according to 2 main criteria:
a. It is probable that future economic benefits associated with the item will flow to the entity
b. The item has a cost or value that can be measured reliably

4. Explain the connection between accruals and deferrals on the one hand and the process
of matching on the other. Give an example
The connection between accrual and deferral could be briefly explained as follows:
Deferrals
Prepaid Expenses : Expenses paid in cash before they are used or consumed for
example Prepaid Insurance
Unearned Revenues : Cash received before services are performed for example
Unearned Revenue/Service Revenue

Accruals
Accrued Revenues : Revenues for services performed but not yet received in cash
or recorded for example Interest Revenue
Accrued Expenses : Expenses incurred but not yet paid in cash of recorded for
example Wages Expense/Interest Expense

The process of matching the deferrals is by recording the asset at incurred date, and make an
adjustment entry at the end of the period to allocate the asset that is expired. For example:
On October 1st Account Inc. paid USD 6.000 for a year fire insurance beginning 1st October.
Account Inc. would therefore make the following entries
1st October Prepaid Insurance USD 6.000
Cash USD 6.000

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 On 31st December Account Inc. should make the following adjusting entries in order to apply
the matching concept (USD 6.000 / 12 x 3 months)
31st December Insurance Expense USD 1.500
Prepaid Insurance USD 1.500

The process of matching the accruals is by recording adjustment entries of payable at the end
of accounting period in order to apply the matching concept. For example:
Match Inc. have a 5-working-days system in its operational. They paid their last employee’s
wages at 26th December which is Friday. The daily wages of Match Inc. are USD 200.
Adjusting entries to record this wages payable could be counted as follows:
31st December Wages Expense USD 600
Wages Payable USD 600

5. Name 3 basic methods of matching and give an example of each

3 basic methods of matching are:
a. Associating Cause and Effect
The ideal way of matching expenses with revenue is by associating cause with effect.
Cause-and-effect relationships are difficult to prove. However, based on what appears to
be reasonable observation, accountants decide that certain goods and services used up
must have helped in the creation of the revenue for that period. It seems reasonable to
assume that the efforts of the sales personnel helped to generate the sales revenue for the
current period. In addition, under revenue recognition principles, there is no cost of sales
if there is no revenue.
Examples are sales commissions, cost of sales, and salaries and wages.
b. Systematic and Rational Allocation
The aim is to recognize expenses in the accounting periods in which the economic benefits
associated with these items are consumed or expire. The principles of allocating the cost
of an asset to current and future periods is well known in accounting. The matching
process begins by associating expenses to segments of time. When this is accomplished,
the amount of expense is assumed to correlate with the revenue for that period.
One common example is depreciation method like straight line method, sum of the years,
and unit of production method. Depreciation is an allocation of cost in a systematic and
rational manner to periods in which the benefits are expected to be received. But,
depreciation is unsatisfactory also for several reasons, including it confuses valuation
method with an event. Another reason is that depreciation is ‘exhaustion of usefulness’.
This is the biggest weakness of cost allocation: it relies solely on assumptions and
estimates which may be arbitrary.

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 c. Immediate Recognition
This is an alternative when the 2 previous methods could not be used. This theory
recognise the outlay immediately as an expense. For example, the advertising expense,
research expenditure, and impairment expenses.

6. Why the current practice of allocation is criticized?

The doctrine of conservatism means that expenses, losses, and liabilities are recognized as
soon as 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 manager’s judgement in the allocation process.
However, as indicated by Sprouse, the allocations process is an essential part of accounting
practice. Determining the amount of costs that have expired is one of the main tasks of the
accountant. But this practice made the balance sheet secondary to the income statement. The
balance sheet also said to be the repository for unexpired costs. Most of what accountants put
in accounting reports is just rubbish.
According to Thomas, the allocations are ‘incorrigible’ in the sense that they are include the
following:
a. They are not capable of verification or refutation by objective, empirical means
b. The patterns of allocation do not exist in the real world, they exist only in the minds of
accountants
c. An input’s individual contribution to the output cannot be known because all the inputs
interact with each other to generate an output
d. Empirical studies do not demonstrate that allocations are useful

7. What are the arguments to defend allocation?

Allocations are arbitrary, but only because the objective of allocations is not defensible. The
objective of allocations in conventional accounting is to determine profit by a process of
matching, in particular by cause and effect. The effectiveness of matching depends on the
existence of a unique and identifiable cause-and-effect relationship between costs and
revenues. The objective of allocations, therefore, should be changed.

8. Determine whether an asset or expense should be charged for the following costs and
state your reasons:
a. Cost of removing two small machine to make way for a larger new machine
Cost of removing two small machine to make way for larger new machine should be
recorded as Cost because it is a price to bring asset to the location and condition necessary
for its intended use.
b. Cost of repairing a floor damaged when a new machine was dropped while being
unloaded

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 Cost of repairing a floor damaged when a new machine was dropped while being unloaded
should be recorded as Cost. Because it is also a price that incurred to bring asset to the
location and condition necessary for its intended use.
c. Cost of a new calculator, $48
Cost of a new calculator could be recorded as Supplies (Cost) if the calculator value is
significant or material to the company (small company of proprietorship company). But it
could be recorded as Expense when the calculator value is not significant or material to
the company (multinational company)
d. Cost of major repairs to equipment (the need for repair was discovered immediately
after acquisition and there is no warranty on the equipment)
Cost of major repairs to equipment (the need for repair was discovered immediately after
acquisition and there is no warranty on the equipment) could be recorded as Cost of the
Equipment because it would an Extraordinary activity (Overhaul) that could prolong the
useful life of the equipment.

9. What are issues for standard setters pertaining to expense recognition and
measurement?
The challenges for the standard setters consider 2 kinds of challenges. First, the matching
concept principles. This specifically states that the matching concept should not be applied in
such a way as to allow the recognition of items in the balance sheet which do not meet the
definition of assets and liabilities (para 95). Second, conservatism principles. This principle
was considered a bias and therefore should be avoided. Although not so explicit, it does
nominate neutrality as a qualitative characteristic of financial information.

10. What are issues for auditors surrounding expenses?

Auditors face issues surrounding the following 3 reasons:
a. The distinction between assets and expenses
Sometimes accountant having a difficult time to differentiate between asset and expenses.
They sometimes do it out of purpose, because the choice to debiting asset or expenses are
rather hard for accountant. But sometimes also, they do it on purpose. A lot of fraud
history began by understating the expenses at the Income Statement, so that Profit will
manipulatively become healthier. This practice is very hard to be proven by auditor
because they need a lot of documents and evidences to judge whether the choice was right
or not.
b. The period in which expenses are recognized
The depreciation allocation method, for example, is a judgemental allocation method for
accountant. They choose the method mostly in favour of management interest. There is
no a satisfying explanation on why accountant chose Decreasing Balance over Straight
Line method, and this will result in the biases or neutrality of financial statement.

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 c. Appropriate measurement of expenses
Another difficult area for auditor is the accounting estimate for example provision on
inventory obsolescence, warranties, losses on lawsuit, and construction contract in
progress. Auditors should test carefully on how the management measure the value of
expenses and searching for supporting evidences to support the reasonableness of the
amount claimed.

REFERENCES:
Godfrey, Jayne, Allan Hodgson, Ann Tarca, Jane Hamilton, and Scott Holmes. (2010). Accounting
Theory, 7th Ed. John Wiley & Sons, Inc. (GOD)
Kieso, Donald E., Weygandt, Jerry J., and Warfield, Terry D. (2014). Intermediate Accounting
2nd Edition IFRS Ed. John Wiley and Sons Inc: USA