Recognition of the acquisition costs of fixed assets and goods for resale
The company's financial result depends on operating income and expenses (OPEX) associated with the activity of an entity. Thus, income and expenses are the most important factors of the financial result. The revenue and expenditure accounts are by-turn the financial performance accounts. The financial results are reflected in the company's main financial statements, the analysis of which allows to assess how effectively the company is operating.
There are three main types of financial statements: the balance sheet, income statement or profit and loss account and cash flow statement. Under accounting rules (Finnish Accounting Act 1336/ 1997, Chapter 5), in order to provide true financial statements, it is essential to attribute income and expenditure to the correct financial year.
Costs of purchasing factors of production
The factors of production are the resources needed to produce and create an output of goods and services. Factors of production include, for example, land, buildings, structures, machine tools, machinery and equipment, tools used in production (fixed capital, fixed asset), as well as raw materials, materials, energy (current capital, current asset), etc. Expenditure is incurred when a factor of production is given to the enterprise. The expenditure of acquiring a factor of production, i.e., the acquisition cost, have to be recorded to the accounts. (Recognition of the acquisition costs, in Finnish: hankintamenojen jaksottaminen).
The purchase price of the factor of production is the basic part of the acquisition cost of goods, raw materials or equipment, it is the base price before on-road costs or any other additional costs. However, before the factors of productions will be ready for use in the company, they have to be transported from the seller to the buyer. Transportation may incur additional costs, such as freight, insurance premiums, possibly customs duties, forwarding costs and other expenses. The acquisition cost is the amount of all-in cost to purchase a factor of production.
Example 1: Cost of goods purchased for resale (cost of goods sold, COGS)
| Purchase price | 2 000 |
| Freight | 50 |
| Insurance premiums | 10 |
| Other costs | 5 |
| Acquisition cost | 2 065 |
The acquisition cost is recorded on the debit side of the purchases account and on the credit side of the cash account.
Example 2: Equipment acquisition cost
| Purchase price | 3 000 |
| Freight and insurance | 70 |
| Installation | 300 |
| Trial run | 20 |
| Acquisition cost | 3 390 |
The acquisition cost of equipment is recorded on the debit side of the equipment account and on the credit side of the cash account.
Any business has to spend money, that is, it incurs expenses in order to generate revenue. However, the costs invested in the purchase of factors of production will be reimbursed upon future revenue of the company. Thus, when a company hand over finished goods, it receives back invested funds through income.
Company's long-term and short-term expenses
Different types of expenses are related to the company's production process in different ways. Machinery, equipment and buildings being applied differently in production than raw materials, goods and labor. A product can only be made once from a certain amount of raw material. Whereas, machines and buildings can be used to make many product generations. Thus, some of the factors of production cause short-term expenses, others the long-term expenses. The short- and long-term expenses are the company's liabilities. On the balance sheet we can see that liabilities are also divided into two categories: short-term and long-term liabilities.
Short-term expenditure is characterized by the fact that it can participate in the production process only once and that it shows the generated revenue right away. Short-term expenses (or current liabilities) include, for example, wages and salaries, taxes, rental costs, operating costs for cars and fuel costs, etc.
Long-term expenses participate in production many times and accrues income gradually over a long period of time. Long-term expenses include, for example, the acquisition of equipment, buildings, machinery and land (fixed assets). The value of fixed assets is transferred to the cost of products step by step. The acquisition costs of the fixed assets are reduced gradually until their value become zero - depreciation occurs. Long-term expenses are depreciated over their useful financial lifetime of the asset.
Short term expenses are financial obligations that are due within one year, whereas long term liabilities extend beyond a year.
When calculating the result for the financial year, these differences between expenses must be taken into account. Revenue for the financial year have to be shown as income in the profit and loss account (P&L statement; in Finnish: tuloslaskelma). Expenses which is not likely to generate further income have to be deducted from corresponding income (Chapter 5, Section 1 of the Finnish Accounting Act 1336/ 1997). An underlying principle of income statement (P&L) preparation is to deduct from revenues only those expenses that generated the income. The income generated during the financial year is recorded in the income statement, as well as the expenses for same financial year from which this income has been received. This means, for example, that income statement prepared for the 2020 financial year reflects costs and revenues associated with the production of 2020.