EXERCISE 4–1 An analyst must be familiar with the determination of income. Income reported for a business entity depends on proper recognition of revenues and expenses. In certain cases, costs are recognized as expenses at the time of product sale; in other situations, guidelines are applied in capitalizing costs and recognizing them as expenses in future periods.

Required:

a. Under what circumstances is it appropriate to capitalize a cost as an asset instead of expensing it? Explain.

b. Certain expenses are assigned to specific accounting periods on the basis of systematic and rational allocation of asset cost. Explain the rationale for recognizing expenses on such a basis.