What is Expense?
Expenses refer to costs businesses undergo to conduct their daily business operations, expand and grow their business, and acquire additional assets, property, and factories. Firms can invest their cash into a few different kinds of investments. They might buy a new building or some real estate.
Unlike your personal expenses, every business expense is tax-deductible, at least to some degree. The list of what counts as a business expense is vast, and, as you’ll see in this entry, includes some things you wouldn’t expect. Having a good working knowledge of business expenses will help you develop a better picture of your company’s profitability, and help you manage your tax bill. It can also save you some money: When you know what your accountant will be looking for when he does your taxes, you can come in completely prepared.
More importantly, how you manage expenses has an enormous impact on your company’s bottom line. If your business isn’t netting a profit, or the profits don’t seem big enough, taking a hard look at the expenses is the first place to start searching for ways to improve profitability. Keep in mind that expense accounts all have normal debit balances, which is the exact opposite of standard revenue accounts.
In fact, there are very few times when you will ever see a credit entry in an expense account. Those rare occasions would be to correct mistakes, to reverse an accrual from an earlier period, or to close out the account. Any other credit postings are probably mistakes, which you need to correct by adjusting entries.
Like most everything else in accounting, there are so many different expenses that it’s easier to group them than it is to look at one very long list. The most common division is between selling expenses and overhead, which are typically called “general and administrative” expenses on financial statements. Remember, costs directly associated with inventory don’t count as expenses. Expenses only include bills you’d have to pay whether or not you ever sold anything.
Two Types of Business Expenses
There are two main categories of business expenses in accounting:
- Operating expenses: Costs associated with the company’s main activities, such as administrative fees and rent.
- Non-operating expenses:
- Expenses that are not directly related to a business’s core operations. A common example would be interest charges and other fees associated with borrowing money.
Firms can invest their cash into a few different kinds of investments. They might buy a new building or some real estate.
Any of these various types of investments would be for capital assets, which would make them capital expenses (sometimes also called expenditures). These are payments made by a company to acquire or improve the performance of long-term capital assets such as equipment, factories, and buildings.
These are typically large and expensive purchases that companies pursue as corporate investments. Another way to look at it is that such capital expenditures increase the overall value of the business. As a result, as asset values rise, so does the owner’s or stakeholder’s net worth. At the same time, the expenses incurred in acquiring the asset will increase the owners’ liability.
Accountants may also choose to include intangible assets such as copyrights, trademarks, and patents in the capital expenses category. In many ways, such assets are amortized, which is similar to depreciation. As a result, businesses should be able to expense the costs of keeping a given capital asset operational, in service, and working properly and efficiently.
While this is correct, it cannot be accomplished under the capital expense categories. In many cases, they are instead treated as operating expenses. However, repairing equipment would almost certainly increase its value. In that case, this would be considered a capital expense.
Another expense that businesses realize analysts call depreciation. This simply means that the value of assets depreciates over time. As it inevitably occurs, it reduces the company’s value.
Such capital expenses can thus be depreciated or capitalized over a set period of time. This time corresponds to what the business world refers to as the asset’s useful life. It is always beneficial to consider an example of a difficult concept such as this.
Companies that purchase office equipment for $20,000 can depreciate this expense over a five-year period. It means they’ll be able to take $4,000 in capital expense depreciation per year. This depreciation can sometimes be accelerated so that businesses can realize the expense benefits sooner.
Not All Expenses Can Be Deducted
The Internal Revenue Service maintains strict rules on what can and cannot be expensed immediately. Startup costs are an excellent example of this. They will undoubtedly increase the firm’s value, but they must be paid for upfront.
The IRS only allows a certain amount of such startup costs to be deducted during the first year of business. The remainder must be amortized. In 2015, the government enacted new legislation allowing for more liberal benefits of corporate depreciation for businesses that purchase capital assets.