Expense

An expense is a cost incurred in completing any transaction by an organization that leads to either revenue generation, creation of the asset, change in liability, or raising capital, etc. . It results in outflow of funds and resources and is essential for the smooth running of the business.

It is important to record them in the financial statements of the company regularly and transparently because it helps in evaluating the income or the net profit that the entity has earned from its operations. It should be managed and controlled efficiently.

Expenses are the costs that every organization needs to incur  daily to sustain its business operations. It’s the basic need of business, i.e., to earn money; one has to invest money, that is, if one is running a business, they need to incur certain expenses in various forms such as salary to employees, wages to workers, rent of property (if rented) cost of goods produced.

The payment of salaries or other direct business expense and the creation of capital assets is also a form of expenditure only. Incurring expenditures are income tax deductible, i.e., one can claim an expense as the reduction from income while paying income tax, but not all costs are tax-deductible. Based on Income tax rules, one can claim costs against income.

It is necessary to consistently record expenses in the income or profit and loss statements to reflect the company's accurate and current financial position. The expense report facilitates the computation of net profit at the end of the year. In addition, it creates the financial information used for management decisions and investors and other stakeholders for investment decisions.

Expenses are of different types which can be tracked using an expense tracker –

Based on Incurring Frequency

#1 - Fixed  Expenses

The costs that do not vary with the production level do not increase or decrease with the number of goods and services produced; they remain constant all the time. Therefore, these expenditures cannot be avoided irrespective of the business run.

Examples

• Rent
• Dues and subscription
• Insurance
• Salaries
• Property tax
• Depreciation

#2 - Variable Expenses

The expenditure directly proportional to sales or production is known as a variable expense. It will go up when the company's production increases and the same may fall if the production is decreased. Variable cost is the amount that is the same per unit.

Examples

• Commission
• Sales Cost
• Direct labour cost
• Cost of raw material
• Inventory packaging supply
• Shipping cost

Based on Nature Of Expense

#1 - Operating Expenses

The expenditures incurred in general business operations are known as operating expenses; these are mandatory costs and cannot be evaded but can be reduced to earn higher gains.

Although it might affect the quality and integrity of operation. Examples:-

• Office supplies
• Freight
• Cost of goods sold
• License Fee
• Selling and administrative costs
• Utility bills

#2 -  Non-Operating Expenses

Costs unrelated to core business operations are included in non-operating expenses. It is an accounting term that describes the cost apart from the company’s daily activities. This expenditure is deducted from the operating profits and is reported at the bottom of a company’s income statement.

Examples include the following -

• Restructuring
• Interest
• Derivative
• Taxes
• Impairment charges

Based on Benefit Accruing Time Period

#1 - Capital Expenses

These costs provide benefits throughout more than one accounting period, i.e., long term, and require a huge amount of outflow of funds or are used in upgrading assets, acquiring land, setting up plants and machinery. Therefore, it does not form part of the income statement; rather, they are capitalized, shown on the asset side of the balance sheet and written off slowly over time.

#2 - Revenue Expenses

These are the costs incurred in the day-to-day running of the business and generally provide economic benefit over a shorter period, usually one accounting period. These are similar to operating/ non-operating day-to-day business running expenditures.

Based on the availability of data, one can calculate the cost. For example, if different expenses are given, one may add and calculate the total; if revenue details and profit details are mentioned, one can calculate expenditure by reverse calculation. Below is the formula for the calculation of costs.

However, let us look at the steps used for the same.

• Identification – It is necessary to identify the different types of expenses based on how and why they are incurred. The common categories are already explained under the types section given above.
• Gather documents – The next step is to collect all the relevant financial records and documents that has the information and details about the business expense. They can be invoices, bills, bank and credit card statements, etc.
• Organize and match – The concerned department should then organize and match the expenses with the documents and check whether they are identified properly, and each amount incurred matches with the supporting document.
• Make total – Then comes the step in which each expense category is totalled, and the final figures are stated calculated to find the total expense incurred in the business.
• Interpretation – This step is very important since, here the company management analyses expense category either through professional help or through expense tracker to find the areas where money is spent and whether those areas need any control perhaps more money is required to be spent for better performance of the department.

Every business organization needs to account for its expenditure. Basic rules of accounting guide the recording of expenditure. They are classified as nominal accounts under accounting terms, and accounting rules provide for debiting all costs and losses incurred by the organization.

It can be recorded by adding up liability or by lowering the assets. While making cost entry, several assets and liabilities are credited. Some expenditures are not definite, or up to a point, so the liability created to record the costs is not easy to understand.

It usually has debit balances, and the detailed cost statement is shown in the income statements. Two methods record expenses

• Cash Basis –  As the name suggests, this recording method uses the actual cash flow when they are paid only, then the entry is passed, and an expense is recorded. For example, stationary comes to the office regularly and is also used, and the bill is generated on the 30th of each month and is paid on the 5th of every month, so here the expense will be booked on the 5th after payment of a bill.
• Accrual Basis – Under the accrual basis, the expenditure is booked as and when the services are received, irrespective of the payment. The example stationary can better understand it is consumed throughout the month, and the bill is received on the 30th and is paid on the 5th here; under this system, the expense will be booked on the 30th.

Let us understand the different types of fund outflow in a business that is used to prepare the expense report, with the help of an example.

Below is a consolidated financial statement of Mercedes Ltd for three financial years. Based on the above classification criteria, one can have an understanding of various types of costs as mentioned in the Financial Statement given below: –

There are some expenses that may be deducted from the net income of the business to reduce the tax to be paid on them. They help in reducing the tax liability. Such cases depend on the country and its laws related to the same. Here are some of their types.

• Some business expense – There are some cash outflows related to daily operation that can be deducted from business income. They may be related to office supply, salary, advertisement, etc.
• Medical needs – In some countries, the money spent for medical purpose which is beyond a certain limit can be deducted from income to get tax benefit. They may be related to medicines, hospital stay, some specific category of treatment, etc.
• Education related – Some funds spent for education sometimes get tax benefit subject to some rules and limits.
• Contribution to charity – Some charitable donation qualify for tax deduction. The contribution may be in the form of money, goods, property, voluntary work, etc.
• Property mortgage – Owners of property who have taken loan for purchase of the same, get tax deductions on the loan interests, subject to some rules and limits.
• State or local tax – In some countries, the payment of state or local taxes can be deducted from net income to get tax benefit.

The two financial terms given above are related but have some difference in their meaning. Let us understand the differences.

• The former refers to any cost that the business has to incur for conducting its daily operation smoothly whereas the latter is a broader term that describes and fund outflow which may be due to daily operation or investment or consumption.
• The former is recorded in the profit and loss statement whereas the latter is recorded at its cost and depreciated over the years.
• The former is usually for the short term, and the latter is generally for the long time.
• Expenses are a subset of expenditure, but all expenditures are not regarded as an expense.

Thus, the points given above clearly explains the differences between the two financial terms.  

This has been a guide to Expense and its meaning. We explain it with examples, differences with expenditure, its types, how to calculate & record. You can learn more about finance from the following articles –

• List of Indirect Expenses
• Expense Report
• Out of Pocket Expense
• Business Expenses