Page 207 - Accounting Principles (A Business Perspective)

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Number of Companies
2003 2002 2001 2000
Percentage of completion 78 82 80 71
Units of delivery 32 26 21 19
Completed contract 9 5 3 5
Source: American Institute of Certified Public Accountants,
Accounting Trends & Techniques (New York: AICPA, 2004), p. 432
Exhibit 28: Methods of accounting for long-term contracts
This company would deduct other costs incurred in the accounting period, such as general and administrative
expenses, from gross margin to determine net income. For instance, assuming general and administrative expenses
were USD 100,000 in 2010, net income would be (USD 3,000,000 - USD 100,000) = USD 2,900,000.

Expense recognition is closely related to, and sometimes discussed as part of, the revenue recognition principle.
The matching principle states that expenses should be recognized (recorded) as they are incurred to produce
revenues. An expense is the outflow or using up of assets in the generation of revenue. Firms voluntarily incur
expense to produce revenue. For instance, a television set delivered by a dealer to a customer in exchange for cash is
an asset consumed to produce revenue; its cost becomes an expense. Similarly, the cost of services such as labor are
voluntarily incurred to produce revenue.
The measurement of expense Accountants measure most assets used in operating a business by their

historical costs. Therefore, they measure a depreciation expense resulting from the consumption of those assets by
the historical costs of those assets. They measure other expenses, such as wages that are paid for currently, at their
current costs.
The timing of expense recognition The matching principle implies that a relationship exists between
expenses and revenues. For certain expenses, such as costs of acquiring or producing the products sold, you can
easily see this relationship. However, when a direct relationship cannot be seen, we charge the costs of assets with
limited lives to expense in the periods benefited on a systematic and rational allocation basis. Depreciation of plant
assets is an example.
Product costs are costs incurred in the acquisition or manufacture of goods. As you will see in the next

chapter, included as product costs for purchased goods are invoice, freight, and insurance-in-transit costs. For
manufacturing companies, product costs include all costs of materials, labor, and factory operations necessary to
produce the goods. Product costs attach to the goods purchased or produced and remain in inventory accounts as
long as the goods are on hand. We charge product costs to expense when the goods are sold. The result is a precise
matching of cost of goods sold expense to its related revenue.
Period costs are costs not traceable to specific products and expensed in the period incurred. Selling and
administrative costs are period costs.

The gain and loss recognition principle states that we record gains only when realized, but losses when
they first become evident. Thus, we recognize losses at an earlier point than gains. This principle is related to the
conservatism concept.
Gains typically result from the sale of long-term assets for more than their book value. Firms should not
recognize gains until they are realized through sale or exchange. Recognizing potential gains before they are
actually realized is not allowed.

Accounting Principles: A Business Perspective 208 A Global Text