Costs incurred to earn revenues are known as an accounting expense is an item that implies a reduction in the company’s assets. In this article you will know what types of expenses there are, how they are classified and the difference between costs and expenses. Keep reading and strengthen your accounting knowledge.
An expense is an expense or, in colloquial terms, an outflow of money that a company or person pays for the purchase of a product, good or service. It usually becomes an investment either tangible or intangible.
Another way of defining expenses is as: “Decreases in the company’s net worth, either in the form of outflows or decreases in the value of assets, recognition or increases in liabilities, provided they are not considered in distributions, monetary or not, to partners or owners” General Accounting Plan.
The expenses produce double economic circulation, due to the fact that at the same time that money leaves (expenditure), a good, a product or a service is entered.
“It is the investment that is made, either directly or indirectly, necessarily, to achieve a tangible good (product)” Elements of Accounting, Volume II. From Howard S. Noble.
- Operational expenses
They are those regular expenses that, although they are not used directly in the production of a good or service, are essential to guarantee the normal operation of a company. Operating expenses include: salaries, office supplies, rent, and activities to drive sales and promote products or services.
- Non-operating expenses
They are temporary expenses, that is, they are not part of the normal operation of the business and therefore are not included in your budget.
- Fines, lawsuits and the replacement of obsolete equipment are just a few examples of the non-operational expenses that a company can face.
- Fixed Expenses: These are expenses that will always be there from month to month and that in the long term will not change.
- Variable Expenses: As their name indicates, they vary either in weeks or months.
- Unexpected expenses: They are used to define an eventual expense within the budget.
Costs and expenses are often confused, since both have several characteristics in common: both accounts decrease the profit of the company, both are included in the income statement and their balance is usually debit.
However, there are important aspects in which they do not coincide, as we will see later.
To know the difference between costs and expenses, let’s start by defining what costs are: with this term we refer to the resources that are invested in the production of a good or service (such as labor and raw materials), with the purpose of obtaining a profit in return.
In other words, for there to be income, some cost must necessarily be incurred.
Contrary to what happens with costs, expenses are not directly used to produce a good or service, although they contribute indirectly to this production process.
For example, in a company dedicated to the manufacture of footwear, the purchase of the leather that is used to make the shoes is a cost and the payroll paid by the administrative staff is an expense; The work of these administrative employees is essential to coordinate aspects of the sales process such as transportation and payment to suppliers, but their work is not directly invested in the manufacture of the product.
To summarize, the difference between costs and expenses is that the former are an outlay to produce a certain good or service; and the second are the expenses incurred by the company, in order to guarantee the development of its operations.
To run a business it is essential to control your current expenses. If before reading this part on expense accounts in accounting you want to know more about managing your company, you can read our article on expense control.
Expenses can be classified according to various particularities:
- Fixed or variable expenses: Fixed expenses are those that, regardless of the company’s results, maintain the same values each month. An example of this type would be the rental of premises. Variable expenses, on the other hand, are those that depend on the volume of the activity. For example, the higher the production, the higher the cost of raw material.
- Expenses with flow or without flow: Expenses with flow refer to those payments made by the company disbursing its own funds. The second type refers to those expenses that do not require a disbursement from the company, such as provision expenses.
- Direct or indirect expenses: Direct expenses refer to those assumed directly by the company, such as payment to suppliers, while indirect expenses are those related to production or marketing.
- Short-term or long-term expenses: Short-term expenses are associated with the liquidity of the organization, that is, the ability of an asset to be converted into cash. Long-term expenses, meanwhile, have to do with solvency. Solvency is associated with accounting accounts since it arises from the difference between assets and liabilities, that is, the money that enters and the money that is lost.
Each of these expenses will be reported in the corresponding expense account in order to prepare the general accounting plan.
An accounting expense account records each of a company’s operations. Expense accounts are divided into four types:
- Asset accounts: Records the assets of a company, that is, its assets and rights. Here belongs, for example, the money available in bank accounts.
- Liability accounts: Account for the debts and obligations of the company. For example, the salary to be paid to employees.
- Net worth accounts: They account for the contributions made by the partners, such as the social capital.
- Administration accounts: They account for the income and expenses of the company. Bank accounts serve as a tool to keep track of money coming in and going out of the organization. This tool will be very useful for preparing reports with precise results.
The accounts are divided into seven groups and each one has a number and a name that identifies them.
Preparing the general accounting plan requires having knowledge of all the accounts of the organization and the information that belongs to each one of them.
As an example, we will present a type of account with its respective expenses.
An important expense in the accounting of any organization is that which refers to representation expenses.
This type of expense includes any event held by the company, that is, those intended to represent or promote the company. Entertainment expenses are a type of operating expense and, therefore, belong to an indirect expense.
The representation expenses accounting account is part of the administration account as it is an expense of the company.