CPE

The expense recognition principle

May 15, 2025

5 min read

Woman factoring in the expense recognition principle while entering in expenses and costs

The expense recognition principle is a key concept in financial accounting to ensure financial statements are accurate and credible. Learn more about what this principle is, how to apply it in both accrual and cash basis, plus get best practices to help you apply it in your work.

What is the expense recognition principle?

The expense recognition principle is the concept of “matching” under generally accepted accounting principles (GAAP). This means that expenses should be recorded and matched in the same accounting period related to the revenues they helped generate. For example, when goods are sold, the expenses related to producing those goods are also recognized during the same reporting period.

Why is the expense recognition principle used?

The objective of using the expense recognition principle is to present a realistic picture of a company’s profitability each reporting period. Using this principle is essential to ensuring accuracy in financial statements, which are necessary for stakeholders to make informed decisions related to the business. It also provides a clearer picture of how businesses convert assets into expenses.

When is expense recognized?

Under cash-basis accounting, income and expenses are recognized when cash changes hands, regardless of accounting period benefitted. Recording expenses when paid, instead of matching it with related revenue may have benefits for income tax purposes. For example, if a company receives a utility bill in September but pays it in October, the expense is recognized in October and will be recorded in the period when the bill is paid.

Under the accrual basis of GAAP, expenses are recognized when incurred, regardless of when actually paid. Going back to the utility bill example, under the accrual basis, the business will recognize the expense in September when the utility was used and billed. Another example, rent paid in advance will be recorded as a prepaid asset and allocated across the periods benefitted.

Accounts payable are necessary to record when an entity receives an economic benefit but has yet to pay for it. Accrued expenses may be necessary to record prior to the exact amount being known for a related expense.

Examples of expense recognition under the accrual basis

Additional accrual-based examples for expense recognition include:

Recognizing commission expenses when the related sale occurs
Accruing for employee bonuses in the year earned
Expensing supplies when used, not when purchased

Challenges and best practices when applying the expense recognition principle

The following may create challenges in proper expense recognition and measurement:

Evolving accounting standards
Changing tax laws and regulations
Complexities in long-term contracts, leases, and areas of accounting uncertainty

Accrual accounting involves recognition of “non-cash” expenses, such as depreciation, amortization, credit loss expenses, warranty obligations, and more. Some costs are systematically allocated over their useful life. Estimates such as these may be highly subjective and subject to bias. Intentional fraudulent financial reporting or unintentional errors can both impact the preparation and fair presentation of financial statements.

There are certain expenses, such as losses from asset impairment, that are expensed as incurrent because they do not contribute to future revenue generation in any measurable way. GAAP defines these exceptions. By aligning expenses with the revenues they help generate, reliable and comparable financial information is generated for investors, creditors, and other users of general-purpose financial statements who tend to focus on net income.

Without consistent expense recognition, trends related to operational efficiency and profitability would be potentially misleading. Financial statements should reflect the true economic activities of a business as they occur. Simultaneously, it is important to properly manage liquidity, ensuring that enough current assets are on hand to meet obligations as they become due. Monitoring working capital requirements, desired current ratio, and using the statement of cash flows as a tool can assist with properly managing an entity’s cash flow needs.

Ensure best practices with Becker’s CPE courses

Staying up to date on accounting standards and tax laws is key to keeping your financial statements accurate and avoiding problems when recording expenses and revenue. Becker makes it easy with CPE courses focusing on the topics that matter most to today’s accounting professionals. For more on expense recognition and GAAP guidelines, check out the following courses: