SUMMARY

ACCOUNTING THEORY
(SUBJECT CODE: ECAU601401)

Chapter 10
EXPENSES
(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
MIND MAP FOR CHAPTER 10

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 CHAPTER 10
EXPENSES

A. Definition of Expenses
In the framework paragraph 70, expenses defined as follows:

“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”

In this sense, the decrease in value pertains eventually to the outflow of cash, could be
called expense as they incurred. Expenses arising in the course of the ordinary activities
include for example cost of sales, wages and depreciation. They usually take the form of the
outflow of depletion of assets such as cash and cash equvalents, inventory, and property, plant,
and equipment (Framework paragraph 78)
Expenses also encompass losses as well as expenses which arise in the course of ordinary
activities. Losses may or may not arise in the course of ordinary activities of the entity.
However, Framework states that losses represent decreases in economic benefits and are
therefore not different in nature from other expenses. Therefore, expense and losses are not a
separate element. Firms who have sought to distinguish them are prohibited according to IAS
1 or AASB 101 Presentation of Financial Statements. The distinction between abnormal and
extraordinary items is no longer permitted.
Henceforth, to make a definition of expenses operational, it must be associated with a
physical activities of the entity, something that the entity really does. So, in that sense, expense
could be described as follows:

“Expenses are production and sales generate revenue and the using up of goods and
services in support of those functions causes expenses to occur”

By the nature, expenses come about because of events (namely, increases in the value of
liabilities or decreases in the value of assets) in the operation of the business. Framework
definition of expenses also refers to outflows or depletions of assets or incurrence of liabilities.
Framework also makes no reference to the relationship of expenses to revenue.
Expenses also sometimes referred as 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. This approach is
accord with the previous argument that expenses represent a value change. The value change
refers to the sacrifice which the firm must make in acquiring the services.

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B. Expense Recognition
The Framework specifies two criteria for the recognition of expenses in paragraph 83
which is:
An item that meets the definition of an element should be recognized if (1) It is probable
that future economic benefit associated with the item will flow to the entity and (2) The item
has a cost or value that can be measured with reliability

The explanation of each criterion could be briefly described as follows:

1. It is Probable that Future Economic Benefits Associated with the Item Will Flow to
The Entity
The concept of probability is very important to consider. Assesments of the degree of
uncertainty attached to the flow of future economic benefits are to be made on the basis
of evidence available when the financial statements are prepared. If the probability
criterion was interpreted as being more or less than 50% its application could be at odds
with the qualitative characteristics of prudence.
2. The Item as a Cost or Value that Can Be Measured with Reliability
This criterion mentioned about prudence and neutrality of expense. Prudence means the
inclusion of a degree of caution in the exercise of the judgements needed in making the
estimates required under conditions of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not understated. The item also mentioned about
freedom from material error and bias, represent faithfully. This means that expense could
purports to represent or could reasonably be expected to represent.

Recognition of an expense occurs simultaneously with the

recognition of an increase in liability or a decrease in assets

C. Expense Measurement
In measuring expenses in the current period, a number of decisions need to be made as to
how expenses should be allocated across future periods of resultant revenue. There are a
number of accounting standards that provide guidance on such matters, but offer a choice in
the method of expense and revenue apportionment. For example, IAS 16 of Property, Plant,
and Equipment allows for the value of a depreciable asset to be measured in a number of ways
after recognition (the cost model or revaluation model) and for several alternative depreciation
options (the straight line, diminishing value and units of production methods). The decision
criteria are meant to be supported by the accrual accounting concept of matching expenses
against revenues in the period to which they relate.

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D. Allocation of Expenses
One approach to measuring expenses is to allocate them to periods to which they relate.
The matching concept forms the basis of accrual accounting. The IASB/AASB Framework
recognizes the matching concept in Paragraph 95 which states
“Expenses are recognized in the income statement on the basis of a direct association
between the costs incurred and the earning of specific items of income”
In this sense, 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. For example, the various components of expense making up the cost of sales are
recognized at the same time as the income derived from the sale of the goods (Paragraph 95)
In practice, the accountants should decide what they will do with the matching process,
including:
 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
However, proper matching is a difficult task, and involves a great deal of judgement on
the part of the accountant. The accountant must identify which assets have been used up
(expired) and the amount that should be written off against revenue for the period. According
to the expert, Paton and Littleton state:
“The problem of proper matching revenue and costs is primarily one of finding
satisfactory bases of association – clues to relationships which unite revenue deductions and
revenue … observable physical connections often afford a means of tracing and assigning. It
should be emphasized, however, that the essential test is reasonableness, in the light of all of
the pertinent conditions, rather than physical measurement”
In conclusion, the matching process is so much very difficult to do, involves a great deal
of judgement, and arbitrary.
In order to solve these problems, associated with determining and measuring costs to be
expensed and to be carried forward, three basic methods of matching are commonly relied on.
These are:
1. 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. Examples are sales
commissions, cost of sales, and salaries and wages. 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.

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 However, in practice, this theory is pretty difficult to apply. One reason is that the
cost attach concept is the basis on which the cause and effect rule rests. Critics also point
out that the rule of cause and effect implies that a certain amount of revenue can be
attributable to a certain amount of expenses.

2. 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. 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.

3. 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.

E. Criticisms of Allocations
The doctrine of conservatism means that expenses, losses, and liabilities are recognized
as soon as possible, even if evidence for them is weak. The assymetrical 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 rubbish.

The cost allocation method made the Balance Sheet

secondary to the Income Statement. It (the Balance Sheet) is just
a repository for the unexpired cost.

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 Furthermore, Thomas argue that to justified, allocation accounting should meet this
following criterias:
1. Additivity: The whole must equal the parts
2. Unambiguity: An allocation method should yield a unique allocation – a clear cut choice
of the method that should me made
3. Defensibility: Once an allocation method is selected, the person making the selection
must be able to provide conclusive argument for his or her choice, and defend it against
other possible alternative methods

According to Thomas also, the allocations are ‘incorrigible’ in the sense that they are
include the following:
1. They are not capable of verification or refutation by objective, empirical means
2. The patterns of allocation do not exist in the real world, they exist only in the minds of
accountants
3. An input’s individual contribution to the output cannot be known because all the inputs
interact with each other to generate an output
4. Empirical studies do not demonstrate that allocations are useful

F. Defence of Allocations
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.

G. Challenges for Accounting Standard Setters

The Framework consider 2 kinds of challenges. First, the matching concept principles.
This spesifically 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.

REFERENCES
Godfrey, Jayne, Allan Hodgson, Ann Tarca, Jane Hamilton, and Scott Holmes. (2010). Accounting
Theory, 7th Ed. John Wiley & Sons, Inc. (GOD)