Expense Accounts – What are they & Some Examples
Generating revenue has its corresponding costs.
For example, when a company sells goods, the corresponding cost would be what it paid for acquiring such goods.
For a company that offers services, the corresponding cost would be the necessary expenses to deliver a service.
Aside from these costs, there are other expenses that are necessary in order to keep the business afloat.
Examples of these expenses are the salaries you pay to your employees, utility bills, rent, etc.
A business will incur expenses as long as it stays in operation.
So it’s important to learn about them if you want your business to stay and grow.
According to the International Accounting Standards Board (IASB), expenses are “are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. ”
As per the above definition, anything that can decrease a business’s net worth can be considered an expense, provided that they are related to the business.
For example, when you pay for rent, your cash is reduced without a corresponding increase in another asset.
In such a case, your net worth will decrease and we can infer that the payment you made for rent is an expense.
But what if you didn’t pay for rent? Your cash won’t be reduced, so you won’t be losing any net worth right?
Well, let’s refer to a part of the definition of expenses by the IASB: “…incurrences of liabilities that result in decreases in equity…”.
Not paying for your rent will result in you incurring a liability.
Since you incurred liability without an economic benefit in exchange, there is no increase in your net worth but rather there’s a decrease instead.
So even if you didn’t pay for it, the rent that you owe would still be considered an expense.
What are Expense Accounts?
Expenses accounts are items within a business’s books that represent the expenses it incurred during its operations.
It is important to maintain expense accounts so that you can keep track of the different expenses that your business incurs.
This can help you in recognizing when you are overspending in a particular aspect of the business.
Examples of Expense Accounts:
Examples of expense accounts are Costs of Sales, Cost of Goods Sold, Costs of services, Operating expense, Finance Expenses, Non-operating expenses, Prepaid expenses, Accrued expenses and many others. Below you’ll find more details of these example expense accounts.
1. Cost of Sales, Cost of Goods Sold, Cost of Services
Cost of sales refers to expenses that are necessary to make a sale.
It can also be viewed as expenses that can be directly attributed to the generation of revenue.
Depending on the type of business, it can be referred to as Cost of Sale, Cost of Goods Sold, or Cost of Services.
Cost of Goods Sold applies to businesses that deal with goods/products, while Cost of Services applies to businesses that offers services.
For businesses that offer both goods and services, they can use Cost of Sales, or both Cost of Goods Sold and Cost of Services.
For businesses that offer services, the cost of sales includes all of the necessary expenses to deliver a service.
For example, for a company that offers security services, its cost of sales will be the wages/labor cost of its security personnel.
For businesses that deal with retail or wholesale of products, the cost of sales includes all of the cost of the products that are sold.
Inventory that has not been sold would not form part of the cost of goods sold.
For businesses that are in the manufacturing industry, the cost of sales will include the cost of direct labor, direct materials, and manufacturing overhead attributable to products sold.
Direct labor refers to the cost of labor (wages) directly related to the manufacturing of a product.
Direct materials are the cost of materials used to manufacture a product.
Manufacturing overhead refers to indirect costs that are incurred during the manufacturing process.
Examples of manufacturing overhead are indirect labor (e.g. salary of supervisors), indirect materials (e.g. machine lubricants, maintenance tools), utility expenses, depreciation, etc.
Any business owner would know that operating a business has other expenses other than the cost of sales.
These expenses that cannot be directly attributed to sales are what we refer to as operating expenses.
These expenses are necessary for the continued operation of the business.
The commonly known examples of operating expenses are:
- Salaries and Wages – this account refers to the payments made to a business’s employees as compensation for their services or labor. Salaries pertain to fixed payments and represent non-hourly labor, while wages pertain to payments based on hourly labor. Do note that this is different from direct labor.
- Utilities Expense – this refers to utility costs such as water, electricity, heating, and waste disposal.
- Rent Expense – this refers to payments made in exchange for rent. Rent expense is usually related to the renting of office space, a warehouse, a piece of equipment, or a whole building.
- Travel Expense – some business activities require travel and transportation. Travel expense refers to the costs of these necessary travels. This could include the cost of fare, vehicle rentals, airfare, etc. However, travel expense is not exclusive to the cost of transportation. Any necessary expenses incurred during the duration of the travel are also included. Examples are the cost of lodging, meals, rental of computers and other communications devices during the travel, etc.
- Supplies Expense – this refers to the cost of supplies used or consumed for business activities such as paper, pens, pencils, paper clips, etc.
- Advertising Expense – this refers to the cost of advertising for the purpose of promoting a brand, a product, or the business itself. Examples are the cost of tv ads, radio broadcasts, direct mail campaigns, newspaper publications, flyers, billboards, etc.
- Training and Development – this refers to the cost of enhancing the knowledge and skills of a business’s employees via training and/or development. While not always necessary for a business, training and development can help in producing competent employees, which in turn help in improving the business.
- Repairs and Maintenance – this refers to the cost of repairing and maintaining long-term assets such as machinery, equipment, furniture and fixtures, buildings, etc. Depending on the amount, the cost of repair and maintenance can either be capitalized or recognized as an expense. For example, replacing the bolts and nuts of a piece of equipment to be able to put it on an acceptable operating level is considered an expense. However, replacing a significant part of it to extend its useful life may be considered for capitalization.
- Depreciation Expense– capital assets or long-term assets are not recognized as expenses outright when they are acquired. Instead, their cost is spread over their useful life. For tangible long-term assets (e.g. equipment, building, machinery), the cost that is recognized as expense for a period is referred to as depreciation expense. (Note: Land cannot be depreciated)
- Amortization Expense– similar to depreciation expense but is applicable to intangible long-term assets (e.g. software licenses, trademark)
- Bad Debts Expense – when a receivable is deemed to be uncollectible, it should be recognized as an expense. This is referred to as bad debts expense. There are two ways to record this expense: the direct write-off method which recognizes bad debts expense when receivables are written-off as uncollectible; and the allowance method which recognizes a portion of the receivables as bad debts expense in the period they are earned and a corresponding contra asset (allowance for bad debts)
- License Fees and Taxes – these are state, local, and foreign taxes and fees required to be paid for the continued legal existence of a business; income taxes are not included in this account
Financing expenses are costs related to financing activities, particularly borrowings from creditors/lenders.
A well-known example is the interest payment on loans.
Since financing expenses are from activities that are not a part of the core activities of a business, they are considered as non-operating expenses.
In most income statements prepared by companies, financing expenses are a separate line item usually presented after the operating expense or EBIT (earnings before interests and taxes).
A business can also incur expenses outside of its operating expenses.
This could include the above-mentioned financing expenses, and other expenses such as losses from one-time transactions (e.g. disposal of an asset, damage due to fire, impairment).
Unlike operating expenses, these expenses are not day-to-day transactions and are not expected to be regularly incurred.
It’s important to separate operating expenses and non-operating expenses in the income statement.
Not doing so would understate the income generated from operating activities, and will not provide an accurate look at the financial performance of a business’s operations.
Let’s take a look at a sample income statement to see how expenses are presented:
As per above illustration, the income statement Walmart Inc. separates the operating expenses from the non-operating expenses.
This is to ensure that the operating income figure only includes revenue and expenses that are related to Walmart Inc.’s operating activities.
When a business pays for its expenses in advance, the amount paid is not recognized as an expense but rather an asset which is referred to as prepaid expenses.
When the related expenses are incurred, the prepaid expense account is credited and a corresponding expense account is debited.
For example, at the beginning of the year, a company paid in advance a year’s worth of rent to its lessor.
Since rent hasn’t been incurred yet at the time of payment, the company will recognize the Prepaid Rent asset account.
By the end of the month, a month’s worth of rent has already been incurred, and so a portion of the Prepaid Rent will be credited, and Rent Expense will be debited as recognition of the rent expense incurred.
When a business has incurred an expense but has not yet paid for it, a corresponding liability account should be recognized which is referred to as accrued expenses.
This is to ensure that an expense is recorded in the period that was incurred.
For example, a company paid its December 2020 rent in January 2021.
If this company only recorded rent when it paid, then that would make the rent expense of the year 2020, and the rent expense of the year 2021 overstated.
Recognizing Expenses: Cash Accounting vs Accrual Accounting
Under the cash accounting method, transactions are only recognized if cash is involved.
As such, expenses are only recognized when they are paid.
This also means that non-cash expenses such as depreciation and amortization cannot be recognized under the cash accounting method.
Under the accrual accounting method, expenses are recorded when they are incurred whether payment has been made or not.
This means that it doesn’t matter whether or not cash is involved as long as expenses are incurred.
For example, a company’s December 2019 utilities expense was only paid in January 2020.
Under the cash accounting method, the expense will only be recognized in January 2020 when it was paid. In contrast, under the accrual accounting method, the expense will be recognized in December 2020 when it was incurred.
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IFRS.org "The IASC’s Framework for the Preparation and Presentation of Financial Statements " Page 4. September 13, 2021
IRS.gov "Deducting Business Expenses" Page 1 . September 13, 2021
IRS.gov "Accounting Periods and Methods" Page 1 . September 13, 2021