Everything about Expense totally explained
In common usage, an
expense or
expenditure is an outflow of
money to another person or group to pay for an item or service, or for a category of costs. For a
tenant,
rent is an expense. For students or parents,
tuition is an expense. Buying food, clothing, furniture or an automobile is often referred to as an expense. An expense is a cost that's "paid" or "remitted", usually in exchange for something of value. Something that seems to cost a great deal is "expensive". Something that seems to cost little is "inexpensive".
In
accounting,
expense has a very specific meaning. It is an outflow of cash or other valuable assets from a person or company to another person or company. This outflow of cash is generally one side of a trade for products or services that have equal or better current or future value to the buyer than to the seller. Technically, an expense is an event in which an
asset is used up or a
liability is incurred. In terms of the
accounting equation, expenses reduce owners'
equity. The
International Accounting Standards Board defines expenses as
» ...decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Bookkeeping for expenses
In
double-entry bookkeeping, expenses are recorded as a debit to an expense account (an
income statement account) and a credit to either an asset account or a liability account, which are
balance sheet accounts. An expense decreases assets or increases liabilities. Typical business expenses include salaries, utilities, depreciation of capital assets, and interest expense for loans. The purchase of a capital asset such as a building or equipment isn't an expense.
Cash flow
In a
cash flow statement, expenditures are divided into operating, investing, and financing expenditures.
An important issue in
accounting is whether a particular expenditure is classified as an expense, which is reported immediately on the business's
income statement; or whether it's classified as a
capital expenditure or an expenditure subject to
depreciation, which isn't an expense. These latter types of expenditures are reported as expenses when they're depreciated by businesses that use
accrual-basis accounting, which is most large businesses and all
C corporations.
The most common interpretation of whether an expense is of capital or income variety depends upon its term. Viewing an expense as a purchase helps alleviate this distinction. If, soon after the "purchase", that which was expensed holds no value then it's usually identified as an expense. If it retains value soon and long after the purchase, it'll be viewed as capital with life that should be
amortized/
depreciated and retained on the
Balance Sheet.
Deduction of business expenses under the US tax code
For tax purposes, the
Internal Revenue Code permits the deduction of business expenses in the taxable year in which those expenses are paid or incurred. This is in contrast to
capital expenditures that are paid or incurred to acquire an asset. Expenses are costs that don't acquire, improve, or prolong the life of an asset. For example, a person who buys a new truck for a business would be making a capital expenditure because they've acquired a new business-related asset. This cost couldn't be deducted in the current taxable year. However, the gas the person buys during that year to fuel that truck would be considered a deductible expense. The cost of purchasing gas doesn't improve or prolong the life of the truck but simply allows the truck to run.
Even if something qualifies as an expense, it isn't necessarily deductible. As a general rule, expenses are deductible if they relate to a taxpayer’s trade or business activity or if the expense is paid or incurred in the production or collection of income from an activity that doesn't rise to the level of a trade or business (investment activity).
Section 162(a) of the Internal Revenue Code is the deduction provision for business or trade expenses. In order to be a trade or business expense and qualify for a deduction, it must satisfy 5 elements in addition to qualifying as an expense. It must be (1) ordinary and (2) necessary (Welch v. Helvering, 290 U.S. 111, defines this as necessary for the development of the business at least in that they were appropriate and helpful). Expenses paid to preserve one’s reputation don't appear to qualify (Welch v. Helvering). In addition, it must be (3) paid or incurred during the taxable year. It must be paid (4) in carrying on (meaning not prior to the start of a business or in creating it) (5) a trade or business activity. To qualify as a trade or business activity, it must be continuous and regular, and profit must be the primary motive.
Section 212 of the Internal Revenue Code is the deduction provision for investment expenses. In addition to being an expense and satisfying elements 1-4 above, expenses are deductible as an investment activity under Section 212 of the Internal Revenue Code if they're (1) for the production or collection of income, (2) for the management, conservation, or maintenance of property held for the production of income, or (3) in connection with the determination, collection, or refund of any tax.
In investing, one
controversy that mounted throughout
2002 and
2003 was whether companies should report the granting of
stock options to
employees as an expense on the
income statement, or shouldn't report this at all in the income statement, which is what had previously been the norm.
Further Information
Get more info on 'Expense'.
|
External Link Exchanges
Do you know how hard it is to get a link from a large encyclopaedia? Well we're different and will prove it. To get a link from us just add the following HTML to your site on a relevant page:
<a href="http://expense.totallyexplained.com">Expense Totally Explained</a>
Then simply click through this link from your web page. Our crawlers will verify your link, extract the title of your web page and instantly add a link back to it. If you like you can remove the words Totally Explained and embed the link in article text.
As long as your link remains in place, we'll keep our link to you right here. Please play fair - our crawlers are watching. Your site must be closely related to this one's topic. Any kind of spamming, dubious practises or removing the link will result in your link from us being dropped and, potentially, your whole site being banned. |
