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  Recognising Expenses

Introduction to Recognising Expenses

After decided on the point at which revenue is recognised, we can now twist to the subject of the recognition of expenses. The relevant convention in accounting is intended to give guidance regarding the recognition of expenses. This convention states that expenses should be corresponding to the revenue that they helped to produced. Other words, the expenses related with a specific item of revenue must be taken into account in similar accounting period as that where the item of revenue is involved. Applying this convention might mean that a specific expense reported in the income statement for a period might not be similar figure like the cash paid for that item throughout the period. The expense reported may be either more or less than the cash paid throughout the period.

Let us refer two examples that demonstrate this point.

  • Materiality convention of accounting. This convention says that, where the amounts included are immaterial, we should refer only what is reasonable. The meaning of this is that an item will be treated like an expense in the period at which it is paid, than being strictly matched to the revenue on which it relates. For instance, a business might find that, at the end of an accounting period, a bill of £5 has been paid for stationery which has yet to be delivered. For a business of whichever size, the time and effort included in recording this as a prepayment would not be justified through the little influence that this would contain on the measurement of profit or financial position. So, the amount would be considered as an expense while preparing the income statement for the current period and ignored in the following period.

Profit, cash and accruals accounting

Revenue does not generally represent cash received and expenses are not the same as cash paid. Consequently, the profit figure (i.e. total revenue minus total expenses) will not generally resent the net cash generated during a period. So it is significant to differentiate between profit and liquidity. Profit is a measure of achievement, or productive effort, than a measure of cash generated. Even though making a profit will raise wealth.

The above points are imitated in the accruals convention of accounting that asserts that profit is the excess of revenue over expenses for a period, not the excess of cash receipts over cash payments. From this Leading on, the approach to accounting that is relies on the accruals convention is often considered as accruals accounting.

So, the statement of financial position and the income statement are both ready on the basis of accruals accounting. Alternatively, the statement of cash flows is not, as it just deals with cash receipts and payments.

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