How to Read a Financial Report: Wringing Vital Signs Out of the Numbers

Chapter 9. A UNIQUE EXPENSE: DEPRECIATION

Brief Review of Expense Accounting

By now you should have a basic sense of accrual-based expense accounting. Cash outlays for operating a business are not necessarily recorded to expense in the same period the cash disbursement takes place. In other words, expenses are not recorded on a simple cash basis of accounting, where all a business needs to do is to keep track of the checks it writes.

Rather, financial statement accounting is concerned with the correct timing for recording expenses—to match expenses with sales revenue or to match expenses with the correct period if there is no direct association between a particular expense and sales revenue. These two guiding principles for recording expenses are explained briefly as follows:

• Matching Expenses with Sales Revenue: Cost of goods sold expense, sales commissions expense, and any other expense directly connected with making particular sales are recorded in the same period as the sales revenue. This is straightforward; all direct expenses of making sales should be matched against sales revenue. You agree, don't you?

• Matching Expenses with the Correct Period: Many expenses are not directly identifiable with particular sales, such as office employees' salaries, rental of warehouse space, computer processing and accounting costs, legal and audit fees, interest on borrowed money, and many more. Nondirect expenses are just as necessary as direct expenses. But nondirect expenses cannot be matched ...