Expense Recognition Principle

This accounting principle says that expenses should be recognized, matched and considered as to be used by the business when all the relevant revenues in the same period  are recognized.

If we do not recognize expenses in the period in which revenues recognized, then expenses related to the current period will be overstated and for the next period will be understated.

For Example, an entrepreneur makes a payment of Rs.80000 to Marketing Manager for the selling of goods for Rs.700000 for the period of next two months. Now, expenses of Rs.80000 should be recognized and matched with the revenues of Rs.700000 in the next 2 months when all the revenues will be recognized.

But, if we match the expenses in the first month, then in the first month the entire expenses are matched with the revenues and expenses are increased by the amount of Rs.80000 that is the amount of payment paid to Marketing Managers. So expenses are overstated in the first month. While it will be understated in the next month by Rs.80000, as we already matched and recognized the expenses with the revenues in the first month.

If this principle is not followed, then the expenses for the first month decrease the income for the period. On the other hand, as expenses are recognized, in our example, in the next two months when revenues are recognized, expenses are decreased in the first month and hence the higher income will be.

You many also be Interested in Matching Principle

Expenses Recognition Principle is based on Accrual Basis of Accounting or Matching Principles in which revenues are recognized only when earned and expenses are recognized only when used by the business.

Due to This Principle, Income Statement shows true and fair view of financial statements as correct and accurate recognition of expenses are matched with the relevant expenses or expenses are recognized when consumed for earning revenue and it does not matter whether revenues are earned not earned.

For Example, it may be possible that the business incurred expenses for the Marketing Campaign to earn revenue but revenues are not earned. In this case, expenses are recognized when all the expenses are consumed, expired or used by the business.

So, it is all about Expenses Recognition Principle. Hopefully, now, you will be able to better understand this topic.