Expenses

How are business expenses calculated? What is included and what is not while determining the expenses? Scroll down to know more!

What is an Expense?

An expense is simply the money spent on business activities on a day-to-day basis or for running a business. It can be a minor expense of buying stationeries for the business or it can be buying an asset for the company. An expense can even be the depreciation value charged on the historical significance of the assets. Sometimes, the costs are even prepaid – like a prepaid rent for the next quarter.

All types of expenses within the business are recorded in the income statement. As per the accrual principle of accounting, the costs are accounted for when incurred and not when paid. In the double-entry system, the cost is debited in the expense account while the credit reduces the assets or increases liability. It is deducted from the total revenue made by the company during the accounting year.

Difference between Cost and Expense

While expense and cost may seem similar to many people, they are pretty different actually in accounting. Cost in financial terms is any purchase in monetary value incurred to gain an asset like a building or a van. In contrast, an expense is spent on operational activities to generate revenue and profit. Expense is the maintenance cost incurred for the building and van purchased. Therefore, all expenses can be termed as costs, but all costs cannot be categorised as expenses.

Nature of Expenses

All the business expenses are recorded in the books of accounts as per the accounting system. The recording is either on a cash basis or an accrual basis. Under the accrual system, the expense is recorded only after the task is obligated, i.e. when the product or service is received. For example – a business is obligated to pay the employee’s salaries only at the end of the month or the first day of next month when the service is received. The wages of April will be recorded in April, even if the payment is made in May. Accrual basis follows the matching principle of accounting to ensure correct reflection in the books for every accounting term.

The second type of system is cash expense. Under this, the transaction will be recorded when a monetary transaction occurs. For example – the business will record the obligated expense of paying salaries in the month the payment is done and not when the company incurred the expense. The salary of April month will be recorded in May if the cash is transferred in May.

What are the different types of Expenses?

Usually, the expenses are of two broad types – Direct Expense and Indirect Expense. Every business expense revolves around these two varieties. The transaction that can be traced is the direct expense, as these expenses are linked to a specific department within the firm. In contrast, businesses cannot outline indirect costs as those are petty in amount and are not confined to one department. These two broad types can be further divided into various categories of expenses.

Categories of Expenses

Expenses can further be segregated into various categories.

Operating and non-operating expenses

Operating expenses are the cost that any business has to incur due to the company’s day-to-day operational activities. For example, the cost incurred to sell goods to consumers is a daily functional activity. Some ordinary operating expenses include salaries, rent, wages, advertising, depreciation and many more. In contrast, non-operating expenses are the type of costs that are indirectly related to business activities. For example, the interest on a loan incurred by the business is a non-operating activity. Taxes, interests and impairment charges are usual types of non-operating costs.

Fixed and variable expenses

Fixed expenses are those costs that the business has to incur after pre-decided intervals. Fixed expenses are not based on units but on usage and time. For example – the rent of the building or plant is a fixed cost. It has to be paid monthly, quarterly or as per the agreement. Salaries and rent are some expected fixed costs.

In contrast, variable expenses depend on the revenue generated by the company. It is generally based on the demand and supply of the company. Like during peak season, manufacturing units require more labour than in the off-season. Therefore wage is a kind of variable expense incurred by the company. Commissions, transactional expenses and seasonal advertising charges are also variable expenses.

Conclusion

In short, we can say that expenses are an integral part of any business. Whether the business is small or big, government or private, and manufacturing or retail – expenses are incurred in every business. The category and type of expense differ for every business depending on the activities performed daily.