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Answer :
Final answer:
The principle of recognizing expenses when they contribute to revenue rather than when they are paid is known as the expense recognition principle. It's central to accrual accounting and helps to accurately match expenses with the related revenues, providing insight into a company's profitability.
Explanation:
Recognizing expenses not when a company pays for them, but when the work associated with those expenses contributes to revenue is an essential principle in accounting known as the expense recognition principle. This principle is a core part of accrual accounting, which dictates that expenses should be recorded in the period in which they are incurred, not necessarily when they are paid. This method provides a more accurate reflection of a company's financial performance and positions expenses in relation to the revenues they help generate.
Not to be confused with the revenue recognition principle, which addresses when revenue should be recognized and recorded, the expense recognition principle is centered on the matching of expenses with the income they produce. Understanding the relationship between cost and revenue is key to determining a company's profitability. Profits are calculated as the difference between revenues and costs, taking into account both explicit costs like wages and raw materials, and implicit costs, which include the opportunity costs of capital and other resources.
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