




A Comparative Review of the Finnish Expenditure-Revenue
Accounting


Timo Salmi
Professor of Accounting and Business Finance
Faculty of Accounting & Industrial Management
University of Vaasa
P.O.Box 700
FIN-65101 Vaasa
Finland

Email: ts@uwasa.fi
WWW: http://www.uwasa.fi/~ts/

SHORTENED TITLE:
Review of Finnish Expenditure-Revenue Accounting

Based on a Working Paper 78-2. European Institute for
Advanced Studies in Management, Brussels, January 1978.
Rewritten in 1993.





Prof. Timo Salmi

A Comparative Review of the Finnish Expenditure-Revenue
Accounting


ABSTRACT: In Finland the accounting theory put forward by
Professor Martti Saario (in 1958, 1959, and partly 1945)
is dominant in accounting legislation, teaching and
research. This paper reviews the theory, states the
unstated economic assumptions on which the theory must be
based, and compares the accounting conventions inherent in
the application of this theory with the conventions in the
generally accepted accounting principles (GAAP). At the
same time it is the purpose to subject this theory to an
international forum, since this has not been done so far.

KEY WORDS: Accounting theory; Accounting principles;
Financial accounting; Accounting model; Finland



                           - 1 -

1. PURPOSE

   Accounting has, aptly, often been called the language
of business. General accounting concepts are used in
communication between researchers in the accounting field
in different countries. The accounting rules, conventions
and practices as well as accounting legislation vary,
however, in some degree from country to country. The
concepts used in teaching financial accounting to business
students may also differ in a fundamental manner.
   The purpose of this paper in the area of comparative
accounting is to facilitate communication about Finnish
accounting research and the concepts used in teaching
financial accounting in Finland. This is done by reviewing
the "expenditure-revenue-accounting" model applied in
Finland. This accounting model is of general interest
because it is an example of taking an unconventional
approach to the going concern convention, and developing
the accounting model starting from the income statement
concepts rather than the internationally more common
expansion from the balance sheet concepts.



                           - 2 -

   The expenditure-revenue accounting model as propounded
in the Finnish language is attributed solely to late
professor Martti Saario _1/. This accounting theory has
been the dominant basis of financial accounting
legislation and teaching in Finland.
   The the financial accounting practices based on
the expenditure-revenue accounting theory resemble in many
respects the accounting practices based on the American
Generally accepted accounting principles, the GAAP. It
will be assumed throughout this paper that the reader is
reasonably familiar with the GAAP.
   This paper is a review of Professor Saario's accounting
theory. The presentation is based on my own interpretation
of expenditure-revenue accounting and GAAP. An attempt is
made not to express any personal preferences concerning
the choice of the accounting concepts. The evaluation of
the potential merits or dismerits of Professor Saario's
expenditure-revenue accounting as a background for
financial accounting practices and teaching, as compared
with accounting practices based on GAAP, will be the
reader's.



                           - 3 -

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



                           - 4 -

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:



                           - 5 -

     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



                           - 6 -

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

   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.



                           - 7 -

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



                           - 8 -

 P   = total income
 I   = the total set of revenue indices
 J   = the total set of expenditure indices
then

(1) P =    r(i)  -   d(j) .
         iI        jJ


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.



                           - 9 -

   The following subcategorization of financing accounts
can be used.

  - cash
  - receivables and payables
  - capital
     - debt capital
     - owners' capital
     - distribution of profits


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

As is seen in Figure 2, the total income is the difference
of the balances of the (total) revenue accounts and
expenditure accounts.



                           - 10 -

   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



                           - 11 -

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



                           - 12 -

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

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.



                           - 13 -

3. ACCOUNTING FOR SEGMENTS OF THE TOTAL PERIOD _9/

31. Segmenting a Total Period

311. Reason for Segmenting

   It is obvious that income determination is trivial if
the total period is under observation. Income must,
however, be determined for periods which usually are much
shorter than the total period. The total period must
therefore be segmented into time intervals called
accounting periods. In financial accounting this
accounting period almost always is one year.
   In expenditure-revenue accounting the stated reason for
the need of yearly income determination is assessing
annual distributable profit. Originally, nothing was said
or assumed of managerial reasons for income determination.


312. The Congruence Principle

   The adoption of the congruence principle is a central
issue of Professor Saario's expenditure-revenue



                           - 14 -

accounting: Per definition, the sum of annual profits (for
accounting periods making up the total period) is
equivalent to the total profit (providing that no mistakes
are made). Thus in expenditure-revenue accounting the
annual profits are considered nothing more than logically
dependent slices of the total profit. The purpose of
accounting is consequently defined as splitting the total
profit into annual profits of the right size.
   My ensuing interpretation is the following. In
expenditure-revenue accounting the timing of the annual
profits is considered inconsequential providing that it
does not affect the distribution of profits. Thus early
annual profits are not assumed to be preferred to later
annual profits, since only the total profit is assumed to
count. This means an implicit assumption of zero cost of
capital to the owner (entrepreneur), i.e. there is no time
value of money in the expenditure-revenue accounting
thinking.
   To recapitulate, I define
 p(t) = annual profit in year t
 P    = total profit (same as total income Formula (1))
 f    = the year of the foundation of the firm
 t(o) = the year of the latest accounting period
 q    = the year of liquidation
then in expenditure-revenue accounting we obviously must



                           - 15 -

have

       t(o)       q                        The sum of
(2a)     p(t) +   p(t) = P if t(o) < q   annual profits
       t=f     t=t(o)+1                    is defined by
                                           the total profit
                                           P, not vice versa.
       q
(2b)    p(t)            = P if t(o)  q
      t=f


313. Discussion on the Causal Relation between Annual and
     Total Profits

   As can seen from the above, my conclusion is that in
expenditure-revenue accounting model the annual profits
are dependent on the total profit, _10/ not vice versa!
The total period ends when the firm has served its task in
generating a total profit, i.e. the desired purchasing
power for the entrepreneur.
   In my view the following counter argument, concerning
the logic of the foundations of expenditure-revenue



                           - 16 -

accounting, can be made at this point. If the annual
income of the firm is positive, the firm is seldom
liquidated. If, however, negative annual incomes are
observed for a prolonged length of time, the firm is
likely to be dissolved. _11/ Because the future is
uncertain, the historical annual incomes are used by the
management and other interested parties as (at least one)
criterion in deciding whether to continue operations or
dissolve the firm (assuming that the decision makers
behave rationally). According to this practical reasoning,
it would be the annual incomes that determine the length
of the total period and the total income, rather than the
other way round, as is assumed in the expenditure-revenue
accounting model. Historical observations, which by
necessity always are the basis for predicting future,
would then be the determining factors rather than a
completed profit earning task.
   The direction of the relationship between the total
profit and the annual profits used in expenditure-revenue
accounting seems to indicate an implicit assumption of
perfect knowledge of the future. Otherwise income
determination is inconsistent until the firm is dissolved.
If the argument put forward is accepted that the firm is



                           - 17 -

dissolved when annual incomes continuously remain
negative, a circular reasoning results in expenditure-
revenue accounting model. This controversy has remained
ignored and unresolved for nearly to fifty decades by now.
_12/


32. Principles of Annual Income Determination

321. Annual Closing of Accounts

   In expenditure-revenue accounting the underlying
function of the annual closing of accounts _13/ is taken
to be the allocation of the relevant portion of the total
profit to the accounting period under observation.
   In order to calculate the annual income, the realized
revenues are first allocated to the pertinent accounting
period. After that, the relevant expenditures are matched
against these realized revenues as expenses.
   The realization convention applied for recognizing the
realized revenues of the accounting period, is the same as
in GAAP, and is therefore discussed no further.
   As will be seen, the matching convention applied is
very similar to the GAAP convention. Differences occurring



                           - 18 -

in the point of view result from the different assumption
about the going-concern convention.


322. Expenses and Unexpired Expenditures

   In order to determine annual income, the expenditures
have to be divided into two categories. The expenditures,
which are deducted from the realized revenues of the
current accounting period, are called expenses. The other
part, which is not yet deducted from the realized
revenues, is called unexpired expenditures.
   In the annual closing of accounts, the unexpired
expenditures become assets._13/_14/ They always will be
converted into expenses in the later accounting periods,
latest by the end of the total period.
   Technically, the unexpired expenditures are transferred
to the later accounting periods via the balance sheet. For
expenditure-revenue accounting the balance sheet thus
becomes necessary as an auxiliary account, when total
profit has to be allocated to individual accounting
periods for annual income determination.
   No accounting practice difference seems to exist here



                           - 19 -

from accounting based on the GAAP, which includes the same
dichotomy between assets and expenses. In American
accounting literature, however, the sequence of reasoning
is often given in a different order when compared with
expenditure-revenue accounting. That is: "when incurred,
expenditures represent assets, which then expire, either
instantaneously or eventually, and thus become expenses".
This is a noteworthy conceptual difference.


323. The Matching Convention

   Expenditures are matched, as expenses, against the
realized revenues of the different accounting periods.
Finally all the expenditures must be thus allocated, in
the form of expenses, to the accounting periods making up
the total period.
   The basis of matching in expenditure-revenue accounting
is given by the association between expenditures and
revenues, and the congruence principle discussed earlier.
From the association principle ("expenditures are a
prerequisite for revenues") it follows that expenditures
expire only when the associated revenues are earned. From



                           - 20 -

the congruence principle ("the sum of annual profits is
equivalent to the total profit") it follows, if the
principle is applied in a consistent manner, that no
losses should be reported for individual accounting
periods if the total income will be positive, i.e. a total
profit occurs. _16/ The following principle has been
propounded by Professor Saario in accordance with the
reasoning above. "In periods with little or no realized
revenues, little or no expenditures can become expenses".
   In actual practice it is seldom possible to establish
the true _17/ association between expenditures and
revenues. _18/ This fact gives rise to various pragmatic
rules for assessing which of the expenditures have expired
and should thus be written off as expenses (and which
expenditures still are unexpired, and should consequently
be entered on the balance sheet). For example, the
relevant Finnish legislation has adopted the rule that all
expenditures which are no more expected to produce
revenues, are expenses. This rule can be regarded as a
corollary of the association and congruence principles,
when applied to matching. -- The role of expectations is
in my opinion important here. If the underlying principle
for watching were given as "expenditures which no more



                           - 21 -

produce revenues have expired (since corresponding future
revenues are known not to exist)", then, taken strictly, a
perfect knowledge of the future would be required with
respect to future revenues.
   Assumptions made about the knowledge of the future
necessarily are critical in any accounting model, since by
definition they should be based on historical transactions
(ex post) rather than future transactions (ex ante). _19/
   In the original presentation of expenditure-revenue
accounting, it has been emphasized that in the framework
of the dichotomy of expenditures ("expenses"/"unexpired
expenditures = assets"), all assets valuation rules should
be seen as nothing but matching rules for annual income
determination. A point that will be taken up further on.


33. Special Topics


   This section reviews the ideas of priority order of
matching and realization depreciation method, which are
sidelines related to expenditure-revenue accounting. This
part can be skipped without a loss of continuity. Because
of space limitations, it will not be possible to analyze



                           - 22 -

the underlying concepts at length, but the priority order
of matching, and realization depreciation are nevertheless
taken up here because they are interesting facets of the
Finnish accounting research history.


331. Priority Order of Matching

   As has been seen, assuming a total profit, annual
expenses must not exceed annual realized revenues
according to the theory of expenditure-revenue accounting.
This notion gives rise to the question of the manner in
which the expenditures should be deducted from the
revenues. The fact is that since expenditures precede
corresponding revenues, the expenditures gradually become
covered by the revenues as they are realized.
   It has been suggested that costs, and hence
expenditures are covered by revenues, not proportionally,
but in a definite priority order. The statement in the
Finnish language of the relevant theory, in Finland called
"The Priority Order Theory of Costs" is attributed to
Professor Martti Saario _20/, and its later refinement
to Professor Jaakko Honko. _21/
   Two criteria were originally considered for determining
a priority order of matching. The first was the length of



                           - 23 -

time it takes an expenditure to cycle once. This criterion
was, however, found unsatisfactory already in the original
presentation. Instead a second criterion was put forward
as the theoretically right one. This was the number of
products or revenue items associated with the expenditure.
The smaller this denominator, the higher the priority of
the expenditure. The following illustration gives the
original priority order of matching suggested.

                                          Direct labor
                                     Direct materials
                                Variable overhead
                           Administrative expenses
                      Equipment and machinery
                 Plant
            Land
       Entrepreneur


332. Realization Depreciation

   Depreciation is one of the most controversial issues in
accounting. Depreciation is to allocate a "long-term"



                           - 24 -

expenditure as expenses over the revenue-producing
life-span of the expenditure. _22/ The most popular
depreciation methods in company practice are the
straight-line, double declining-balance,
units-of-production, and the years'-digits _23/ methods.
   Double declining-balance and the years'-digits methods
are accelerated depreciation methods, i.e. methods with
decreasing depreciation charges. They often are advocated
on the basis of an alleged diminishing revenue-earning
power resulting from economic and physical age. _24/
   An entirely different pattern of depreciation is
suggested in "compound interest" (or "annuity")
depreciation method. The revenues associated with the
long-term expenditure are assumed to be made up by two
parts. The first is the return (interest) on the long-term
expenditure. The rest is the amount of the long-term
expenditure recovered = depreciation. With the passage of
time the part due to interest decreases, when the
unrecovered portion of the expenditure gradually
decreases. Consequently, the annual amount of the
expenditure recovered increases. Thus,a depreciation
method with increasing depreciation charges results. _25/
   Next we discuss the idea of realization depreciation in
more detail.



                           - 25 -

   The basic assumptions of expenditure-revenue
accounting, discussed throughout this paper, originate
from Professor Saario's doctoral dissertation in 1945 on
the "realization principle and depreciation of fixed
assets", and foremost from his papers in 1958 and 1959.
_26/ In his dissertation and a later paper in 1961 _27/ he
put forward the realization depreciation method:
   As was discussed earlier, from the association
principle of expenditures and revenues it follows that
expenditures expire (become expenses) only when associated
revenues are realized. As we saw, from congruence
principle it follows that losses are not consistent for
any of the accounting periods if the net income for the
total period is positive. Depreciation (an expense) is,
consequently, strictly tied to the revenues produced by a
long-term expenditure. _28/ Therefore, in accordance to
this thinking, depreciation has absolutely nothing to do
with physical aspects of the relevant assets. In periods
of no revenues no expense is relevant, and no depreciation
can thus be made then. The idea of realization
depreciation is, on the basis of the principles above,
that depreciation is directly dependent on the associated
revenues, being thus a function of them. The relation is
given by the internal-rate-of-return model.



                           - 26 -

   To illustrate, consider an extremely simple numerical
example involving an expenditure of $100 at the beginning
of the first year, and revenues of $57.6 at the end of the
first and the second year. The internal rate of return on
this investment is 10%, since $57.6/1.10 + $57.6/1.102 =
$52.4 + $47.6 = $100. The depreciation for the first year
is $52.4 and $47.6 for the second. Contrary to the
compound-interest depreciation method, which is also based
on the rate of return on the long-term expenditure,
realization depreciation usually leads to an accelerated
depreciation pattern. _29/


34. Treatment of Expenditure, Revenue, and Financial
    Accounts in Closing

   Figure 4 illustrates the principle of the closing
process by depicting the closing entries for
expenditure-revenue bookkeeping. _30/

FIGURE 4  Closing Entries

   In order to calculate the annual net income all



                           - 27 -

realized revenues and expenses of the accounting period
are gathered from the books on the income statement
account, which is the first closing account. The annual
net income is given by the balance of the income statement
account.
   Unexpired expenditures and financing accounts are
closed on the balance sheet account, which is the second
closing account. Undistributed profit is entered on the
credit-side as retained earnings. _31/ Thus the concept of
retained earnings, which is central in accounting based on
the GAAP, does not come up in expenditure-revenue
accounting at all before this stage.
   The function of the balance sheet is to transfer the
ending balances of the unexpired expenditures and the
financing accounts on to the next accounting period, where
they become the beginning balances of the relevant
accounts. The balance sheet does not have the same
conceptual emphasis as a statement of the financial
position of the firm as in accounting based on the GAAP.
   Income determination is the underlying purpose of
expenditure-revenue accounting. As has been discussed at
great length in this paper, matching naturally is the
critical stage of annual income determination. All rules



                           - 28 -

affecting matching through determination of expenses or
unexpired expenditures affect the annual income.
  It was stated earlier in this paper that in
expenditure-revenue accounting it is emphasized that all
asset valuation rules are nothing but matching rules for
annual income determination. In other words any valuation
of the balance sheet items should be considered a
valuation of the annual income. The reasoning is easily
demonstrated by writing out the fundamental equation of
matching elucidated by Figure 4.

Expenditures = Expenses           + Unexpired expenditures
               (income statement)   (assets/balance sheet)

When the expenditures are given, any change
(increase/decrease) made in the value of assets means a
reverse change (decrease/ increase) in expenses. A change
in the expenses alters the annual income respectively
(increase/decrease).
   The convention of conservatism is relevant in matching
in expenditure-revenue accounting. The convention implies
that, given a choice, the higher of the alternative
expense figures should be selected. The convention is the



                           - 29 -

same as in the GAAP _32/ except that in expenditure-revenue
accounting a conservative asset valuation is regarded as a
conservative expense estimate, because of the underlying
philosophy of expenditure-revenue accounting.
   The conventions of consistency and materiality, which
also affect matching, do not differ from the GAAP in
principle. Of course there are differences from the U.S.
application in some details of practices because of
differing accounting legislations.



                           - 30 -

4.  RECAPITULATION

   The differences between financial accounting based on
the Finnish expenditure-revenue accounting and the
American GAAP are the difference in the going-concern
convention, and using the cash account as the central
reference account instead of owners' equity. Consequently,
the monetary measurement convention is even more
pronounced in expenditure-revenue accounting than in
a financial accounting based on GAAP. The balance sheet
considered a secondary, auxiliary account connecting the
successive accounting periods. A circular reasoning is
used in expenditure-revenue accounting with regard to
relationship between annual profits and the total profit.
The time value of money is ignored.
   The difference of the Finnish and GAAP thinking is most
pronounced in teaching introductory accounting, because
the former is focused on income determination and is
geared around the income statement.  On the other hand,
the financial accounting practices are not significantly
different between the Finnish and the GAAP view.







                           - 31 -

NOTES AND REFERENCES:

1. Martti Saario, "Yrityksen rahoitus ja kirjanpidon
   meno-tulo- teoria." Teollisuustaloudellisen Yhdistyksen
   vuosikirja (1958); Martti Saario, Kirjanpidon
   meno-tulo-teoria (Helsinki: Kustannusosakeyhtio
   Otava, 1959); Some aspects were presented already in
   Martti Saario, Realisointiperiaate ja
   kayttoomaisuuden poistot tuloslaskennassa. (English
   summary: Realization Principle and Depreciation of
   fixed Assets.) Doctoral dissertation. Publications of
   the Helsinki Research Institute for Business Economics
   6. (The Helsinki School of Economics, 1945).

2. This is the basic (different) assumption from which the
   Finnish expenditure-revenue accounting model follows.
   The other important difference is not considering
   transactions in the terms of the balance sheet, and
   thus not (directly) utilizing the "assets = liabilities
   + owners' equity" equation (although it can be shown to
   hold in expenditure-revenue accounting).

3. The expenditures relate to the financial flows
   resulting from acquiring inputs needed to produce
   outputs generating the revenues. In other words they
   relate to the financial flows not directed to the
   capital market (see Figure 1). As will be seen, the
   expenditures are measured in accordance with the
   historical cost convention, and they are recorded on
   the accrual basis.

4. The revenues relate to the financial flows generated by
   the outputs. In other words they relate to the
   financial flows not originating from the capital market
   (again see Figure 1). As will be seen, the standard
   conventions apply also in measuring the revenues.

5. The term total income is used this time rather than the
   total profit in order to indicate the fact that also a
   total loss is conceivable in case the whole business
   venture backfires. Thus the word "profit" has the
   connotation of positive income in this paper.







                           - 32 -

6. Note that this will definitely not mean a suggestion
   for a cash-flow accounting model. Accrual basis is
   used.

7. While this simplification is in effect for the
   illustrative reasons the subcategory "accounts
   receivable and payable" is not needed in financing
   accounts.

8. This term is deliberately used instead of "financial
   statements" in order to stress their underlying nature.

9. The reader may find it helpful to consult Figure 4 in
   reading the text of this chapter.

10. In accordance with the original sources (c.f. footnote
    1) I use here the word profit instead of income.

11. This assertion is supported by any study of
    bankruptcy.

12. This argument was brought to my attention by Professor
    Veikko Jaaskelainen of the Helsinki School of
    Economics.

13. In our discussion, "closing of accounts" will denote
    the whole process of preparing the annual financial
    statements.

14. In the U.S. accounting terminology it is often said
    that the expenditure is capitalized. (In the Finnish
    terminology we say it to be "activated".)

15. Unrealized revenues, which have been collected in
    advance by the firm, are naturally treated in an
    analogous manner. They become liabilities instead of
    assets in the annual closing of accounts.

16. In addition to the consistency requirement,the
    following reasoning has been used to support this
    argument. Consider, for example, a three-year total
    period with a total profit of $100. If the annual
    incomes were defined as $200, -$100, and $0
    respectively, and all the reported incomes were
    distributed (as taxes and dividends), then the firm
    would in fact be distributing also its basic capital
    in the first year.






                           - 33 -

17. For a discussion on the possibility of existence of a
    true association see the discussion on inseparability,
    multiplicity, and instability of causal networks by
    Yuji Ijiri, The Foundations of Accounting Measurement:
    A Mathematical, Economic and Behavioral Inquiry
    (Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1967),
    58-64.

18. Except, of course, in the rare cases where the
    business venture is so short-lived that the total
    period can actually be observed. In that case all the
    expenditures naturally are relevant expenses.
    Historically, it is interesting to note that the early
    (1600's) bookkeeping related to one time
    project-ventures.

19. In Finnish this question has been thoroughly discussed
    in Jaakko Honko. Yrityksen vuositulos (English
    summary: The Annual  Income of an Enterprise and Its
    Determination: A Study from the  Standpoint of
    accounting and Economics). (Publications of the
    Helsinki Research Institute for Business Economics 25.
    Helsinki, 1959).

20. Martti Saario  "Kustannusten etuoikeusjarjestyksesta."
    Huugo Raninen 50 vuotta. (Helsinki, 1949).

21. Jaakko Honko. Op.cit.

22. Although not always approved of by accountants,
    depreciation can also regarded as the part of the
    annual revenues which should be assigned to acquiring
    assets represented by the long-term expenditures.

23. The years'-digits method is not used in financial
    accounting in Finland.

24. Accelerated depreciation methods defer income-tax
    outlays. This increases the present value of aftertax
    income even though the sum of the taxes remains
    unchanged.

25. The advocates of this method point out that it is the
    only depreciation method which results in the correct
    rate of return on the unrecovered part of the
    expenditure, throughout the life-span of the
    expenditure. See Timo Salmi and Martti Luoma,
    "Deriving the Internal Rate of Return from the
    Accountant's Rate of Profit: Analysis and Empirical
    Estimation." The Finnish Journal of Business
    Economics (No. 1, 1981), 20-45.







                           - 34 -

26. Martti Saario, op.cit.  (C.f. footnote 1).

27. Martti Saario. "Poistojen paaoma-arvo ja
    oikea-aikaisuus," Mercurialia MCMLXI (Helsinki 1961).

28. It should be noted that it is impossible to ascertain
    an association between a long-term expenditure and
    revenues, except under highly simplifying assumptions,
    as pointed out in connection with realization
    depreciation by Reijo Ruuhela, Yrityksen kasvu ja
    kannattavuus. (English summary: A Capital Investment
    Model of the Growth and Profitability of the Firm.)
    Doctoral Dissertation. (The Helsinki School of
    Economics, 1972), p. 32; Also see Reijo Ruuhela & Timo
    Salmi & Martti Luoma & Arto Laakkonen, "Direct
    Estimation of the Internal Rate of Return from
    Published Financial Statements." The Finnish
    Journal of Business Economics (No. 4, 1982),
    329-345.

29. Unless the revenues resulting from the expenditure
    increase annually at a rate greater than the internal
    rate of return.

30. For simplicity the revenues have not been divided into
    realized revenues and deferred revenues in Figure 4,
    since deferred revenues seldom are a major item. The
    division is naturally observed in expenditure-revenue
    accounting in accordance with the realization
    convention, nevertheless.

32. For simplicity, Figure 4 does not delineate the
    difference between net income and retained earnings.
    Retained earnings are net of dividends distributed.
    Also other differences are conceivable like the
    effects of currency translation in multi-currency
    accounting situations.

33. For instance, the lower of cost or market rule is
    applicable. One special feature of the Finnish
    accounting and tax legislation is that up to quarter
    of the direct cost of the inventories can be written
    off as expense.
