In: Accounting
3.10 It has been said that ‘all costs become expenses’.
a) Distinguish between ‘costs; and ‘expenses’.
b) Do you agree with this statement? Why/why not?
Answer:- A cost might be an expense or it might be an asset. An
expense is a cost that has expired or was necessary in order to
earn revenues. We hope the following three examples will illustrate
the difference between a cost and an expense.
A company has a cost of $6,000 for property insurance covering the
next six months. Initially the cost of $6,000 is reported as the
current asset Prepaid Insurance. However, in each of the following
six months, the company will report Insurance Expense of $1,000—the
amount that is expiring each month. The unexpired portion of the
cost will continue to be reported as the asset Prepaid
Insurance.
The cost of equipment used in manufacturing is initially reported
as the long lived asset Equipment. However, in each accounting
period the company will report part of the asset's cost as
Depreciation Expense.
A retailer's purchase of merchandise is initially reported as the
current asset Inventory. When the merchandise is sold, the cost of
the merchandise sold is removed from Inventory and is reported on
the income statement as the expense entitled Cost of Goods
Sold.
The matching principle guides accountants as to when a cost will be
reported as an expense.