What Is an Expense?
You need to know that expenses, both operating and nonoperating, are everything that costs a company to make money. As a business owner, I see expenses as every cost your business runs into to produce income. Common ones include payments to suppliers, employee wages, factory leases, and equipment depreciation.
Key Takeaways
- There are two main categories of business expenses in accounting: operating expenses and nonoperating expenses.
- Accountants record expenses through one of two accounting methods: cash basis or accrual basis.
- Businesses write off tax-deductible expenses on their income tax returns, following guidelines set by the Internal Revenue Service (IRS).
Understanding Expenses
One of your company's main goals is to maximize profits, and you achieve this by boosting revenues while keeping expenses in check. But if you cut expenses too much, it could hurt you—for example, paying less on advertising reduces costs, but it also lowers your visibility and ability to reach potential customers. Businesses like yours are allowed to write off tax-deductible expenses on income tax returns to lower taxable income and tax liability. However, the IRS has strict rules on which expenses you can claim as deductions.
How Expenses Are Recorded
You break down revenues and expenses in your income statements. Accountants record expenses through cash basis or accrual basis. Under cash basis, you record expenses when paid. In contrast, under accrual, you record them when incurred. For instance, if you schedule a carpet cleaning, with cash basis, the expense goes in when you pay the invoice; with accrual, it's when you receive the service. Expenses are generally recorded on an accrual basis to match them with revenues in accounting periods. Remember, expenses are used to calculate net income—the equation is revenues minus expenses.
Types of Business Expenses
There are two main categories: operating and nonoperating. Operating expenses relate to your company's main activities, such as cost of goods sold, administrative fees, office supplies, direct labor, and rent—these come from normal, day-to-day operations. You deduct them from revenues to get operating income, which is profit from direct business activities. Nonoperating expenses aren't directly tied to core operations; examples include interest charges and costs from borrowing money. These occur outside daily activities, like from restructuring, reorganizing, debt interest, or obsolete inventory. We keep them separate so you can see clearly how much your company earns from core activities.
Special Considerations
Capital expenses, or CapEx, are funds you use to acquire, upgrade, and maintain physical assets like property, buildings, plants, technology, or equipment. The IRS treats these differently from other expenses—while most business costs can be expensed the year they're incurred, capital ones must be capitalized and written off over time. There's a schedule for the portion of a capital asset you can write off each year until it's fully claimed, varying by asset type. Not all expenses can be deducted; to qualify, they must be ordinary and necessary—common in your industry and crucial for earning income. You can't claim personal, nonbusiness expenses, lobbying, penalties, or fines as deductions.
What Are Examples of Expenses?
Examples include rent, utilities, wages, maintenance, depreciation, insurance, and cost of goods sold—these are recurring payments needed to operate your business.
What Are the Types of Expenses?
You can categorize them in various ways. Fixed expenses don't change with production, like rent or a mortgage. Variable expenses do change, like utilities and cost of goods sold. They can also be operating (directly related to running the company) or nonoperating (indirectly related).
Is a Salary Considered an Expense?
Yes, salary is an expense and reported as such on your income statement.
The Bottom Line
An expense is a cost your business experiences in running operations, including wages, maintenance, rent, and depreciation, plus nonoperating ones. You deduct expenses from revenue to arrive at profits, and certain ones are deductible to reduce your tax burden. If you have questions about deductibles, consult a tax expert.
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