Accot 02/05

Expense Recognition Principles

• Expense Recognition Principle: Expenses should be recognized in the period when the related benefits are consumed or incurred.

Example Scenarios

1. Salary Expense Recognition

   • January: Salespersons earned $4,200 in commissions for January sales.

   • Recognition: Yes, recognized as salary expense in January since the benefits are consumed in that month.

2. City of Omaha and Waste Management

   • Contract for trash collection service costing $12,000 for the year.

   • Should City Recognize Expense in January?: Yes, the service is used starting January 1.

   • Amount: $1,000 for January (1/12th of the annual contract). The remaining $11,000 becomes a prepaid expense.

3. University of Florida and Airline Tickets

   • Paid $10,000 in advance for tickets to a March tournament.

   • Recognition in January?: No, no expense incurred in January as the game is not yet played.

4. Houston Community College Employee

   • Employee worked 8 hours on January 31 at $15/hour.

   • Recognition: Yes, recognized salary expense for the hours worked, totaling $120 ($15 x 8 hours).

5. Insurance Policy Payment

   • Bond Company paid $3,600 for a 12-month fire insurance policy starting January 1.

   • January Expense Recognition?: Yes, recognize $300 in January (1/12th of the policy).

6. Phone Service Bill from January

   • Ziggler Company received a bill for $230 for January phone service.

   • Expense Recognition: Yes, recognize full expense of $230 in January even though payment occurs later.

Summary of Scenarios

• Recognize expenses in the period benefits are utilized.

• Deferrals: Payments made in advance for future benefits (e.g., prepaid expenses for insurance or rent).

• Accruals: Recognizing expenses before cash payments (e.g., salary expenses, utilities).

Journal Entries and Timing Differences

General Journal Entry Guidelines

• For Recognized Expenses: Debit Expense Account, Credit Cash or Accounts Payable (depending on cash payment timing).

• For Deferrals: Debit Prepaid Expense, Credit Cash upon payment; later, Debit Expense, Credit Prepaid Expense.

• For Accruals: Debit Expense, Credit Accounts Payable when recognizing before payment.

Revenue Recognition Principles

1. Revenue Recognition: Revenue is recognized when it is earned, regardless of when cash is received.

2. Timing Scenarios:

   • Cash Collected at Sale: Debit Cash, Credit Revenue.

   • Cash Collected Before Earned: Record as Unearned Revenue (liability); Debit Cash, Credit Unearned Revenue.

   • Cash Collected After Earned: Record as Accounts Receivable; Debit Accounts Receivable, Credit Revenue.

Key Concepts

• Deferral: Cash received before service/product delivery, creates a liability (Unearned Revenue).

• Accrual: Revenue recognized before cash is received; creates an asset (Accounts Receivable).

• Review of journal entry applications is essential for understanding expense and revenue recognition.