1. Assignment 2:
What is the different between costs and expenses?
Answer Question 1: Different between Cost and Expenses:
The difference between cost and expense is a considerable one, and yet the
terms are frequently intermingled even in the published works of accounting
authors. This makes the difference extremely difficult to understand for those
people training to be accountants, and who are therefore uncertain about the
nature of the terms.
Cost most closely equates to the term expenditure, so it means that you have
expended resources in order to acquire something, transport it to your location,
and set it up. However, it does not mean that you have consumed the item that
you acquired. Thus, an item for which you have expended resources should be
classified as an asset until it has been consumed. Examples of asset
classifications into which purchased items are recorded are prepaid expenses,
inventory, and fixed assets.
For example, the cost of an automobile may be $40,000 (since that is what you
paid for it) and the cost of a product you built is $25 (because that is the sum
total of the expenditures you made to build it). The cost of the automobile likely
includes sales taxes and a delivery charge, while the cost of the product probably
includes the cost of materials, labor, and manufacturing overhead. In both cases,
you have expended funds to acquire the automobile and the product, but have
not yet consumed either one. Accordingly, the first expenditure is classified as a
fixed asset, while the second one is classified as inventory. Similarly, an advance
paid to an employee is classified as a prepaid expense, if the employee has not
yet worked sufficient hours to earn the payment.
Expense is a cost whose utility has been used up; it has been consumed. For
example, the $40,000 automobile you purchased will eventually be charged to
expense through depreciation over a period of several years, and your $25
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2. product will be charged to the cost of goods sold when you eventually sell it to a
customer. In the first case, converting from an asset to an expense is achieved
with a debit to the depreciation expense account and a credit to the accumulated
depreciation account (which is a contra account that reduces the fixed asset). In
the second case, converting from an asset to an expense is achieved with a debit
to the cost of goods sold and a credit to the inventory account. Thus, in both
cases, we have converted a cost that was treated as an asset into an expense as
the underlying asset was consumed. The automobile asset is being consumed
gradually, so we are using depreciation to eventually convert it to expense. The
inventory item is consumed during a single sale transaction, so we convert it to
expense as soon as the sale occurs.
Another way of thinking of an expense is any expenditure made to generate
revenue under the matching principle, which was particularly apparent in the last
case, where inventory was converted into an expense as soon as a sale
occurred. Under the matching principle, you recognize both the revenue and
expense aspects of a transaction at the same time, so that the net profit or loss
associated with the transaction is immediately apparent. Thus, a cost converts to
an expense as soon as any related revenue is recognized.
A key reason why a cost is, in practice, frequently treated exactly as an expense
is that most expenditure are consumed at once, so they immediately convert
from a cost to an expense. This situation arises with any expenditure related to a
specific period, such as the monthly utility bill, administrative salaries, rent, and
so forth.
Unfortunately, cost and expense tend to be used interchangeably even within the
accounting terminology. Even the "cost of goods sold" term just used should
really be called "expense of goods sold," since it refers to costs that were
charged to expense when a sale of goods was completed.
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3. The master glossary of the accounting standards codification that is maintained
by the Financial Accounting Standards Board does not define either term;
consequently, the definitions given above are derived from common usage.
References:
Garrison, R.H, Noreen, E.E & Brewer, P.C (2011), Managerial Accounting, 13 th
Edition, McGraw Hill.
Nor Aziah Abu Kasim, Rozita Amiruddin, Rozainun Haji Abdul Aziz & Che
Hamidah Che Puteh (2011),
Management Accounting, 1st Edition, Oxford
University Press.
http://www.accountingtools.com/questions-and-answers/what-is-the-difference-between-costand-expense.html
http://www.dummies.com/how-to/content/the-difference-between-costs-and-expenses.html
http://blog.accountingcoach.com/cost-expense/
http://blog.accountingcoach.com/cost-expense-2/
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