Last editedOct 20212 min read
The world of expenses in accounting can seem complex. What is an expense account? And what are direct and indirect expenses? These are frequent questions asked by those new to operating in business. In this article we’ll address those queries and more in order to give you a clear idea of what expenses are in small business accounting.
Definition of expenses in accounting
An expense in accounting refers to the money spent and the costs incurred by a company in pursuing revenue. Simply put, account expenses are the costs involved in running a business, and collectively they contribute to the activities involved in generating profit.
While they might seem identical in general lexicon, there is an important difference between a “cost” and an “expense” when it comes to accounting.
Cost refers to the finances put forward in order to purchase an asset. The use and consumption of these assets are expenses.
So, while an example of a cost might be the purchase of a van by a company, the payment for petrol and servicing are expenses.
It follows, therefore, that all expenses can be categorised as costs, but not all costs are necessarily expenses.
All expenses will be recorded and noted in a business’s income statement. The total revenue minus expenses determines the net profit of a company.
Direct expenses vs. indirect expenses in accounting
A question new business owners often ask is: what are direct expenses in accounting?
Direct expenses and indirect expenses are different terms used to describe a business’s expenditure. They are distinguishable in order to retain accuracy in financial reports.
The key difference between direct expenses and indirect expenses in accounting is that direct expenses are traceable. They are limited to a single department and are for the purpose of that department only. Indirect expenses, on the other hand, are untraceable as they are not linked to any particular division of a business.
Usually, direct expenses are linked to the manufacturing of a product, for example, the cost of raw materials. Direct expenses therefore fluctuate according to the rate of production, but should be consistent for each unit of production.
Indirect expenses are confined to office expenditures, such as rent, utilities and employee salaries.
Categories of business expenses
Beyond direct and indirect expenses, there are a number of other ways to categorise expenses which you need to be aware of. These include the following:
Operating vs. non-operating expenses
Operating expenses refer to expenditure relating to the principal activities of your business, such as the cost of the materials used to make a product you sell.
Non-operating expenses, meanwhile, are those not directly related to the operations involved in business. This might be the interest on a business loan, for example.
Fixed vs. variable expenses
Fixed expenses do not depend on the number of units you sell. For example, rent, which will remain the same no matter the activity level of your business.
Variable expenses, however, are those which directly depend on how much a company is selling. For example, employee wages which may increase should they be required to work more hours.
Deductible vs. non-deductible expenses
Deductible expenses are expenses which a business can deduct from its income before taxation. Non-deductible expenses are ones which cannot be subtracted from income.
What is an expense account?
An expense account helps you oversee and organise the various expenses of your business over a certain duration of time.
You can break this down into sub-accounts so that you can clearly see where money is going and organise your finances accordingly.
Employees may have access to an expense account in order to pay for expenditures related to business. This may include, for example, reimbursing an employee who spent money on dinner with a client.
Expense accounts are temporary. You therefore need to close expense accounts and reset them at the beginning of a new period.
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