cost principle

Examples of cost principle in the following topics:

• Effects of GAAP on the Income Statement

  • The historical cost principle: It requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities.
  • The revenue recognition principle.
  • The matching principle.
  • The full disclosure principle.
  • This suggests that the amount and kinds of information disclosed should be decided based on a trade-off analysis, since a larger amount of information costs more to prepare and use.

• Reporting of Financial Statement Analysis

  • Historical cost principle: requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities.
  • Depreciation and Cost of Goods Sold are good examples of the application of this principle.
  • Full Disclosure principle: implies that the amount and kinds of information disclosed should be decided based on trade-off analysis, as a larger amount of information costs more to prepare and use.
  • Information disclosed should be enough to make a judgment while keeping costs reasonable.
  • Consistency principle: the company uses the same accounting principles and methods from period to period.

• Depreciation

  • Depreciation refers to two very different but related concepts: the decrease in value of assets (fair value depreciation), and the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle).
  • One such cost is the cost of assets used but not currently consumed in the activity.
  • Such costs must be allocated to the period of use.
  • Where the assets produce benefit in future periods, the matching principle of accrual accounting dictates that those costs must be deferred rather than treated as a current expense.
  • Describe the relationship between allocation of cost and the matching principle when calculating depreciation

• Introduction to GAAP

  • Historical Cost Principle: requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities.
  • Full Disclosure Principle: Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use.
  • Information disclosed should be enough to make a judgment while keeping costs reasonable.
  • Please note: Historical cost and the matching principle are slowly disappearing, having been replaced by FASB No. 157 which requires companies to classify assets based on fair value.
  • Cost-Benefit Relationship: the company considers the costs necessary to prepare the information and what benefit users will get from it.

• Cost-Benefit Analysis

  • Cost-benefit analysis, which is also sometimes called benefit-cost analysis, is a systematic process for calculating the benefits and costs of a project to society as a whole.
  • The guiding principle is to list all parties affected by a project and add a negative or positive value that they ascribe to the project's effect on their welfare.
  • Financial costs tend to be most thoroughly represented in cost-benefit analyses due to relatively abundant market data.
  • The cost side of the analysis would include the cost of land that must be acquired prior to construction, construction, and maintenance.
  • Costs might include construction and maintenance.

• Accounting Perspectives on Long-Lived Assets

  • If accounting principles allow recognition of an asset, the next issue concerns which items can be included and which items need to be expensed.
  • Figuring the cost of an item takes into consideration more than just the purchase price.
  • Added to that would be any taxes paid, less any discounts received, cost of transportation that a company pays to bring the item to where it needs to go, and the cost of getting it ready for use.
  • So, for example, the cost of land would include any attorney fees, real estate fees, title fees, back taxes that need to be paid, and the cost of preparation for the lands intended use.
  • Basically any costs that are necessary to get an item or land ready to use for business is included in the cost of the item.

• Costs and Production in the Short-Run

  • AFC is fixed cost per Q.
  • It is the variable cost per Q.
  • Total Cost (TC) is the sum of the FC and VC.
  • Average Total Cost (AC or ATC) is the total cost per unit of output.
  • In Principles of Economics texts and courses MC is usually described as the change in TC associated with a one unit change in output,

• Difference Between Economic and Accounting Profit

  • Explicit costs are costs that involve direct monetary payment.
  • In contrast, implicit costs are the opportunity costs of factors of production that a producer already owns.
  • Accounting profit is the difference between total monetary revenue and total monetary costs, and is computed by using generally accepted accounting principles (GAAP).
  • These consist of the explicit costs a firm has to maintain production (for example, wages, rent, and material costs).
  • Economic profit is the difference between total monetary revenue and total costs, but total costs include both explicit and implicit costs.

• Reporting R&D Cost

  • R&D costs may be expensed.
  • Choice of the appropriate accounting treatment for such costs should be guided by the degree of certainty of future benefits and the principle of matching revenues and expenses.
  • In this case, the contract usually specifies that all direct costs, certain specific indirect costs, plus a profit element, should be reimbursed to the enterprise performing the R&D work.
  • Because reimbursement is expected, such R&D costs should be recorded as a receivable.
  • Summarize how to report research and development costs on the financials statements

• Inventory Techniques

  • This expression describes the principle of a queue processing technique or servicing conflicting demands by ordering process by first come, first served (FCFS) behavior, where the persons leave the queue in the order they arrive, or waiting one's turn at a traffic control signal.
  • There are two commonly used average cost methods: Simple weighted average cost method and moving average cost method.
  • This gives a Weighted Average Cost per Unit.
  • Finally, this amount is multiplied by Weighted Average Cost per Unit to give an estimate of ending inventory cost.
  • Each time, purchase costs are added to beginning inventory cost to get Cost of Current Inventory.