An expense is a cost incurred in completing any transaction by an organization which leads to either revenue generation creation of the asset, change in liability or for raising capital, etc.
Every organisation needs to incur certain costs daily to sustain it. 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.
Not only the payment of salaries or other direct expenses but the creation of capital assets is also a form of expenditure only. Incurring of expenditure 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.
Types of Expenses
Expenses are of different types –
Based on Incurring Frequency
#1 – Fixed Expenses
The costs that do not vary with the level of production that is they do not increase or decrease with the number of goods and services produced, they remain constant all the time. These expenditures cannot be avoided irrespective of the business run.
- Dues and subscription
- Property tax
#2 – Variable Expenses
The expenditure that is directly proportional to sales or production is known as a variable expense. It will go up when the production of the company increases and the same may fall if the production is decreased. Variable cost is the amount that is the same per unit.
- Sales Cost
- Direct labour cost
- Cost of raw material
- Inventory packaging supply
- Shipping cost
Based on Nature Of Expense
#1 – Operating Expenses
The expenditure which is 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 probity of operation. Examples:-
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- Office supplies
- Cost of goods sold
- License Fee
- Selling and administrative costs
- Utility bills
#2 – Non-Operating Expenses
Costs that are not related to core business operations are included in non-operating expenses. It is an accounting term that describes the cost which takes place apart from the company’s daily activities. This expenditure is deducted from the operating profits of a good and is reported at the bottom of a company’s income statement.
Examples include the following –
- Impairment charges
Based on Benefit Accruing Time Period
#1 – Capital Expenses
These costs which provide benefit over a period of more than one accounting period, i.e. long term and require a huge amount of outflow of funds or are used in upgrading of assets, acquiring land setting up plant and machinery. It does not form part of the income statement; rather, they are capitalised and are shown in the asset side of the balance sheet and are written off slowly over a period of time.
#2 – Revenue Expenses
These are the costs incurred in day to day running of the business and generally do provide economic benefit over a shorter period of time, usually one accounting period. These are similar to operating/ non-operating day to day business running expenditure.
How Do We Calculate Expenses?
Based on the availability of data, one can calculate the cost. If different types of expenses are given, one may add and calculate the total, if Revenue details along with profit details are mentioned, one can calculate expenditure by reverse calculation. Below is the formula for the calculation of costs.
How Do We Record An Expense?
Every business organisation 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 rules of accounting provide for debiting of all costs and losses incurred by the organisation.
It can be recorded by adding up liability or by lowering the assets. While making cost entry, several assets and liability are credited. There is are expenditure that is not definite or up to a point, so the liability created to record the costs are not easy to understand.
It usually has debit balances, and the detailed statement of cost is shown in the income statements. Expenses are recorded by two methods
- Cash Basis – As the name suggests, this recording method uses the actual cash flow that is when they are paid only, then the entry is passed, and an expense is recorded. For example, stationary comes to 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 it can be better understood by the example stationary is consumed throughout the month, and the bill is received on 30th and is paid on 5th here under this system expense will be booked on 30th.
Example of Expense
Given below is a consolidated financial statement of Mercedes Ltd for three financial years. Based on the above classification criteria, you one can have an understanding of various types of cost as mentioned in the Financial Statement given below: –
This has been a Guide to Expense and its Meaning. Here we discuss types of expenses along with a practical example and detailed explanation. You can learn more about finance from the following articles –