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It was the SEC’s position that such future benefits were not sufficiently clear as to warrant capitalization.
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However, highlighting the subjectivity of its decision, a disagreement arose with the SEC as to the extent to which those costs actually benefited future periods. reporting them as assets and later amortizing orĪOL decided initially to capitalize its subscriber acquisition costs.capitalize those recurring expenditures.Management then is faced with the decision of whether to: The method is particularly subjective when a transaction lacks a “ discrete purchase event” as with property, plant, and equipment, and instead involves the incurrence of recurring expenditures over time. The company records property, plant, and equipment at cost and then employs the straight-line method as a systematic and rational method for allocating that cost over the asset’s lives.Īs seen with AOL, however, this systematic and rational allocation approach to matching is not always so straightforward. Depreciation and amortization of buildings, equipment and fixtures is computed principally by the straight-line method over the useful lives of the various assets. Property, plant and equipment are carried at cost. Consider the following example taken from the annual report of American Greetings Corp.: Companies record assets purchased at their cost and then allocate that cost over the future periods that benefit. It is from this systematic and rational allocation approach that we get our current method of accounting for depreciation expense. This reporting technique seems straightforward and works reasonably well for most expenditures. Thus, because a long-lived asset contributes toward the generation of revenue over several periods, the asset’s cost must be allocated over those periods. As a result, a “ systematic and rational allocation” policy is used to approximate the matching principle. Most costs do not have such a clear association with revenue as can exist for inventory costs or a sales bonus or the estimated costs of a warranty repair. In this way, expenses incurred are matched with the recognized revenue.Īllocating Costs in a Rational and Systematic Manner Similarly, a bonus paid a salesperson for completing a sale or the estimated cost of providing warranty repairs over an agreed-upon warranty period are expensed in the same time period that the related revenue is recognized. That way the cost of the inventory and the revenue generated by its sale are reported on the income statement in the same time period. Rather, those costs are charged to expense when the inventory is sold. The principle ties “ expense recognition” to “ revenue recognition“ dictating that efforts, as represented by expenses, be matched with accomplishments (i.e., revenue), whenever it is reasonable and practicable to do so.įor example: inventory costs are not charged to cost of goods sold when the inventory is purchased. Back to the AOL case, the principle guiding these decisions, known generally as “ the matching principle”, is simple enough.