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 costDirect Labour CostDirect labor costs refer to the total cost incurred by the company for paying the wages and other benefits to its employees against the task performed by them, which are straight away related to the manufacturing of the products or provision of the services.
- 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 expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.; 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:-
- Office supplies
- Cost of goods soldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.
- 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 expensesNon-operating ExpensesNon operating expenses are those payments which have no relation with the principal business activities. These are the non-recurring items that appear in the company's income statement, along with the regular business 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 periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance., 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 statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.; rather, they are capitalised and are shown in the asset side of the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. 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 accountsNominal AccountsNominal Accounts are the general ledger accounts which are closed by the end of an accounting period. Their balance at the end of period comes to zero so they don't appear in the balance sheet. 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 balancesDebit BalancesIn a General Ledger, when the total credit entries are less than the total number of debit entries, it refers to a debit balance. A debit balance is a net amount often calculated as debit minus credit in the General Ledger after recording every transaction., 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 basisAccrual BasisAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. , 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 statementConsolidated Financial StatementConsolidated Financial Statements are the financial statements of the overall group, which include all three key financial statements – income statement, cash flow statement, and balance sheet – and represent the sum total of its parents and all of its subsidiaries. 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 –