Expense Recognition

Spending money and recording an expense are not always the same event. Under accrual accounting, an expense is recognised when the business uses the goods or services, not necessarily when it pays.

There are several common patterns. Costs directly linked to sales, such as the cost of products sold, are recorded in the same period as the related revenue, following the matching principle. Costs that benefit several periods, such as equipment, are spread over those periods through depreciation. Costs that benefit only the current period or have no clear future benefit, such as most office salaries and advertising, are recorded as they are incurred.

For example, if a business pays 24,000 for two years of insurance upfront, it does not record a 24,000 expense immediately. It records 1,000 a month as the cover is used, with the unused part held as a prepaid asset.

Recording expenses in the right period is essential for accurate profit figures. Delaying expenses can make a period's profit look better than it really is.