Question

An accounting must be familiar with the concept involved in determining earning of a business entity. The amount of earing reported for a business entity is dependent on the proper recognition in general of revenue and expenses at the time of product sale; in other situation, guidelines have been developed for recognizing costs as expenses or losses by other criteria.
1- Explain the rationale for recognizing costs as expenses at the time of product sale.
2-What is the rationale underlying the appropriateness of treating costs as expenses of a period instead of assigning the costs to an asset?
3- Identify the necessary conditions in which it could be appropriate to treat a cost as loss.

Answer 1

Rationale for recognizing costs as expenses at the time of product sale

Costs generally be recognised as expenses as and when they have incurred during business. But some of the costs will be known at the time of sale only. Examples are sales commission as a percentage of sale amount, transportation of sold goods/machinery, installation costs (if any). These should be recorded as expenses only at the time of sale.

Rationale underlying the appropriateness of treating costs as expenses of a period instead of assigning the costs to an asset

Generally costs incurred upto the installation of asset including expenses like purchase cost, installation, transport, insurace, taxes and any other incidental expenses will be form part of asset cost only. After the asset came into use, the running expenses like operating, repairs and maintenance will be debited to profit and loss statement instead of debiting to respective asset account.

Necessary conditions in which it could be appropriate to treat a cost as loss.

A loss is associated with a "peripheral" or "incidental" transaction. Examples of losses include the loss on the sale of an asset used in the business, loss from a lawsuit settlement, and loss from retirement of bonds. However, there are some losses that are closer to operations, such as the loss on write-down of inventory from cost to market.

Conditions in which it could be appropriate to treat a cost as loss are

1. There should be no probable market rate for respective product

2. Any cost incurred which results in no materialization

3. Any unforeseen activities occured during transit or at factory like natural calamities, accidents of fire or water etc.,

4. Distress sales i.e, selling of a product at a price lower than the cost

And conditions varies from facts of the situation