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Expenses are costs incurred in running and maintaining a business to produce goods or services. There are operating as well as non-operating expenses. Expenses that are connected with the main activity of the business are referred to as operating expenses. An operating expense is a daily expense. Other expenses that are non-operating expenses arise not from the business’s normal activities. An example is the interest expense which is not related to the trading activities or rendering services of a firm.

Under the accrual basis of accounting, some expenses are recognized as having been incurred in an accounting period while others are related to sales such as the expense of cost of goods sold, sales commission and discount. Expenses recorded as having been used in an accounting period as shown on the income statement include utilities expense, insurance expense, advertising expense, interest expense and office salaries expense. These expenses are not recorded based on the period they are paid. For example, commissions expense should appear on the income statement in the same period as the sales to which it is related regardless of when the commission is actually paid. Likewise, the cost of goods sold should appear with the related sales on the income statement regardless of when the supplier of the goods is paid.

Expenses are paid with cash. But not all cash payments are for expenses. Thus, a big sum used to partially or fully pay off a loan, though reduces a business’s cash asset, is not considered an expense payment. However, expenses can be incurred well after a cash payment has been made. This is usually provided for as in depreciation. For example, a machine with an estimated life-span of five years is bought for $2,000. For each of the five subsequent years, an equal amount of $400 is written off as an expense item.

Expenses must not be confused with expenditures. The expenditure might be for a long-term asset such as plant and machinery. Such capital expenditure retains its value long after its purchase, and is shown on the balance sheet with annual deductions for depreciation. Depreciation is an expense that will have to be charged to the profit and loss account.

Expenditure can be for an immediate expense such as petrol.  The expense of petrol for motor vehicle is consumed immediately when the vehicle is used whereas depreciation expense for the motor vehicle is distributed over a number of years. Another example is the office equipment such as computers or a photocopying machine which is the capital expenditure. The operating expense is the maintenance and electricity charges, toner and paper used for the equipment.

Whenever an expense is incurred, it reduces an asset or adds to the liability, and involves actual transfer of cash from a firm or person to another. The purchase of an asset such as a machine or equipment is not an expense. The accounts required to be recorded are as follow.

  1. Debit Expenses account
  2. Credit Cash / Accounts Payable / Prepaid Expenses account

In the above, expenses are debited to their respective expense accounts as an expense account is a debit balance. When a debit entry is made in an expense account, the Cash account is credited to show that cash is paid at the time of the expense. If cash will be paid after the expense is recorded, the Accounts Payable account is credited. The Prepaid Expenses account is credited if cash is paid in advance such as insurance premiums.

Last Updated (Thursday, 02 September 2010 19:20)