Financial Accounting: Expense Methods, Assets, Depreciation, Inventory, Liabilities

Nature of Expense vs. Cost of Sales Method

There are two primary methods for presenting expenses in financial statements:

• Nature of Expense Method: This method presents gross output, such as revenue and changes in inventories generated during a period, along with the corresponding expenses. Expenses are categorized according to their nature (e.g., salaries, rent, utilities).
  • Advantages: Provides information on the nature of the costs required to run the business.
  • Disadvantages: Does not provide information on the costs incurred for specific activities like production or research and development.
• Cost of Sales Method: This method presents the revenue generated in a period and the corresponding expenses for production, as well as expenses for other activities required to run the business. Expenses are presented according to their function (e.g., cost of goods sold, selling expenses, administrative expenses).
  • Advantages: Provides information on the costs of the activities required to run the business.
  • Disadvantages: Does not provide information on the nature of costs incurred. It is more complex and requires a somewhat discretionary allocation of costs to functions.

Assets and Liabilities

Assets (AS)

• Non-current Assets:
  • Property, Plant, and Equipment (PPE)
  • Other Long-Term Assets
  • Intangible Assets
• Current Assets:
  • Cash
  • Inventories
  • Accounts Receivable
• Total Assets

Equity and Liabilities (E+L)

• Equity (E):
  • Subscribed Capital
  • Retained Earnings
• Current Liabilities:
  • Short-Term Notes Payable
  • Accounts Payable
• Non-current Liabilities:
  • Long-Term Notes Payable
  • Long-Term Bonds
• Total Equity and Liabilities

Depreciation Calculation Example 1

Original Depreciation: (24,000 - 4,000) / 5 = 4,000

New Depreciation: (20,000 + 4,000) / 6 = 4,000

2018:

• Depreciation Expense: 4,000
• Inventories: 4,000

2019:

• Inventories: 4,400
• Residual Value: 4,000
• Cash (Attachment): 400
• Depreciation Expense: 4,000
• Inventories: 4,000

Depreciation and Impairment Loss Example 2

Depreciation: (360,000 - 0) / 6 = 60,000

Year 3: 360,000 - 60,000 * 3 - 110,000 = 70,000

• Depreciation Expense: 60,000
• Bus: 60,000
• Impairment Loss: 70,000
• Bus: 70,000

Yes, there is an impairment loss because the bus had an accident. Extraordinary depreciation for an expected permanent decrease in value is considered an impairment loss.

FIFO Inventory Valuation

Purchases:

• 400 units at $10.50, Total Cost: $4,200
• 100 units at $11.00, Total Cost: $1,100
• 200 units at $11.50, Total Cost: $2,300
• Sold: 430 units at $16.00

FIFO Cost of Goods Sold: $3,070 (2,300 + 70 * 11)

Adjustment: 270 units, $10.75 average unit cost, $2,902.50 (200 * 10.75 + 70 * 10.07)

Ending Inventory: 270 units, $2,902.50

Liabilities vs. Provisions

Liabilities are obligations for which the timing and amount of the settlement are known as of the closing date of the respective fiscal period. Provisions are liabilities of uncertain timing and/or amount. As a basic principle, liabilities are recognized at their settlement value, which is the amount required to settle the liability. For provisions, a reasonable commercial assessment is required, and this assessment must be made in accordance with the prudence principle.