Department of Accounting and Finance, University of Vaasa,
Finland

2. Accounting for the Entire Life-Span of the Firm

21. Fundamental Concepts

211. Adoption of the Total Period

Income determination is taken as the underlying purpose of expenditure-revenue accounting. This basic premise should continuously be borne in mind throughout this paper.

The fundamental difference between the Finnish expenditure-revenue accounting and GAAP is discarding the going-concern convention in the former. _2/ Instead, the total period from the firm's foundation to its liquidation will first have to taken under observation in order to define the total profit for the entire life-span of the firm.

212. Expenditures, Revenues, and Financing

In expenditure-revenue accounting the fundamental objective of the entrepreneur is taken to be earning a profit, because it provides the desired purchasing power. The objective of the business firm is assumed to be the same. In order to earn a profit the firm must commit expenditures as a prerequisite of revenues. Thus, in principle, there is a fundamental association between expenditures _3/ and revenues _4/.

For the entire life-span of the firm the sum of the receipts exceeds the sum of the disbursements if the revenues for the total period exceed the expenditures, provided that distributions of profits have not exceeded the profit for the total period. Expenditures, however, precede corresponding revenues. It is this discrepancy in timing that gives rise to the need of outside financing. Two mutually exclusive, comprehensive sources of outside financing are defined. The first is paid-in capital from the owners. The second is debt.

The life-span of the firm, i.e. the total period thus entails:

   1. Acquiring outside financing
       a. paid-in capital from owners
       b. debt
   2. Expenditures
   3. Revenues
   4. Repaying outside financing
       a. debt
       b. paid-in capital to owners
Furthermore, the financial flows through the firm, as will be illustrated by Figure 1, include the distribution of profits among creditors, government, and owners; in other words interest, taxes, and dividends.

213. Determination of Total Profit

The expenditure-revenue accounting approach was developed taking the total period under observation. When the going-concern convention is thus discarded and the total period from the firm's foundation to its liquidation is under observation, the matching problem automatically becomes solved and income determination trivial, in principle. For the total period all expenditures have to expire and become expenses, because no more revenues to match against exist, per definition, after the firm has been dissolved. Hence, the TOTAL income _4/ is the difference between the TOTAL revenues and TOTAL expenditures.

The aim of expenditure-revenue accounting is solely the determination of income. The evaluation and further usage of the observed income is strictly separated from income determination, and is limited outside expenditure-revenue accounting.

214. Entity, Money Measurement and Cost Conventions

Finnish accounting text-books introducing expenditure-revenue accounting usually elucidate financial accounting with the help of some version of Figure 1.

Figure 1. The Financial and Material Flows through the Firm

                       CAPITAL MARKET

                       paid-in and
                       debt capital
                           :
              distribution :
              of profits   :       repayment
               -interest   :         :
               -taxes      :         :
               -dividends  :  +------+
 (expen- )                 :  :
 (ditures)                 :  :                  (revenues)
 payments   +--------------+--+---------------+  payments
 for inputs !              :  :               !  from outputs
 {----------+- accounts {- cash {- accounts {-+--------------
            !  payable             receivable !  financial process
...................................................................
            !         production flow         !  physical process
 ---------} ! ------------------------------} ! -----------------}
 physical   !                                 !  physical output
 input flow +---------------------------------+  flow

 INPUT MARKET                                  OUTPUT MARKET
In accordance with the entity convention the firm in Figure 1 is the relevant entity. It acquires a set of "physical" inputs, transforms the inputs into outputs in the production process and sells the resultant outputs. This physical process is reflected in the financial process as depicted by Figure 1. Financial accounting (in our case expenditure-revenue accounting) is defined as a description of the financial process of the business entity under observation. Figure 1 emphasizes the central conceptual role assumed for cash in expenditure-revenue accounting. _6/ Money measurement convention is used in registering the flows of the financial process. This is natural because, per definition, monetary flows are under observation. The measurement of the flows of the financial process is made according to the (historical) cost convention (c.f. "stable dollar" assumption).

Thus, in comparison with accounting based on the GAAP, no changes are made in entity, money measurement, or cost conventions in accounting based on the expenditure-revenue accounting model.

215. Summary

To recapitulate, I denote
r(i) = the i:th revenue observed from the financial process
d(j) = the j:th expenditure observed from the financial process
P = total income
I = the total set of revenue indices
J = the total set of expenditure indices

then

(1) P =  sum r(i)  - sum d(j) .
         icI         jcJ

22. The Accounting Process

221. Expenditure, Revenue, and Financing Accounts

Three sets of accounts are defined for recording purposes in expenditure-revenue accounting. They are

  1. Financing accounts
  2. Expenditure accounts (not "expense" accounts)
  3. Revenue accounts
All transactions arising in financial accounting for the firm can be recorded on accounts belonging to the above three categories.

The following subcategorization of financing accounts can be used.

222. Cash Basis

For instructive reasons first consider the recording of transactions on cash basis. _7/ Figure 2 depicts the recording of the basic transactions on T-accounts.

Figure 2. Recording Transactions

   . . . . . . . . . . . . . . .
   .    Sources of cash        .         Sinks of cash
   .                           .
   .             +-------------.--------------+
   .             :   Financing . accounts     :
   .             :             .              :
   .  Revenue    :  Capital    .   C a s h    :     Expenditure
   .  accounts   :  accounts   .   +     -    :     accounts
   .  =========  :  =========  .  ---------   :     ===========
1a .      !      :      ! -----+----} !       :          !
 b .      !      :      ! -----+----} !       :          !
2  .      !      :      !      .      ! ---------------} !
3  .      ! ------------+------+----} !       :          !
4a .      !      :    {-+------+------+--     :          !
 b .      !      :    {-+------+------+--     :          !
   .    : !      +-------------.--------------+          ! :
   .    :                      .                           :
   . . .:. . . . . . . . . . . .                           :
        :                                                  :
        :                   Total income                   :
        :                   ------------                   :
        +------------------------!--}                      :
                              {--!-------------------------+
                                 !
As is seen in Figure 2, the total income is the difference of the balances of the (total) revenue accounts and expenditure accounts.

All the rules needed for recording various transactions can be deduced from the following convention of expenditure-revenue accounting, which corresponds to the dual aspect convention of the GAAP.

   Every transaction is recorded as a debit and
   equal credit. An increase in cash is recorded
   as a debit on cash account.
For example, it can be deduced with the help of Figure 2 that a revenue is credited on the relevant revenue account, whereas an expenditure is debited (charged) on the relevant expenditure account. The details of recording different transactions in accordance with the expenditure-revenue accounting model have naturally been described in great detail in Finnish accounting text-books.

The position of the cash account in Figure 2 (and later in Figure 3) reflects the central conceptual role of cash. In expenditure-revenue accounting cash is used as the reference account instead of owners' equity, which is the reference account for accounting based on GAAP. It must be stressed, however, that this does not imply a suggestion for cash-flow accounting. The rules for recording transactions do not differ from GAAP rules, since the equation "assets = liabilities + owners' equity" can be derived as a corollary of the "debit equals credit, and increase in cash is a debit"- convention.

Figure 2 shows that for closing purposes an additional account is needed outside the financing / expenditure / revenue accounts classification. Such additional accounts are called closing accounts. _8/ There are exactly two of them. One is the income statement ("total income" in Figure 2), the other is the balance sheet. When the total period is under observation, the balance sheet is not relevant, because in liquidation at the end of the total period the balance sheet becomes an empty set.

Note that no distinction has yet been made between expenditures and expenses.

223. Accrual Basis

Accrual basis is applied in the Finland just as it is applied in the USA. It is applied in accordance with the realization convention. Thus expenditure-revenue accounting is not any different in this respect from accounting based on the GAAP. In order to accommodate for the application of the accrual basis, accounts receivable and accounts payable are augmented. This is elucidated by Figure 3.

Figure 3. Accrual Basis in Recording Transactions

   Revenue     Accounts      C a s h     Accounts   Expenditure
   accounts    receivable    +     -     payable    accounts
   =========   ----------    -------    ---------   ===========
1      !           !            !           ! ---------} !
2      !           !            ! --------} !            !
3      ! --------} !            !           !            !
4      !           ! ---------} !           !            !
The transactions depicted in Figure 3 are
  1. Purchase on credit
  2. Settlement of this credit
  3. Credit sales
  4. Payment for the credit sales is received.
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