Reviewed by Aug 27, 2020| Updated on
What is Meant by Expense?
An expense refers to the cost of operations that a company spends to generate revenue. General expenses include payments to vendors, employee wages, factory rent, and depreciation on plant and equipment.
Entities are allowed to write off expenses allowed as deductions in their income tax returns. It can lower their taxable income and, in turn, their tax liability. However, the Income Tax Act has pre-defined rules on which expenses are allowed to be claimed as a deduction by businesses.
Businesses account for expenses by either of the two accounting methods: cash basis or accrual basis. There are two main classifications of business expenses in accounting: operating expenses and non-operating expenses.
How Does Expense Work?
Profit maximisation is the primary objective of the management of any business organisation. It can be achieved by increasing revenues and keeping expenses in check at the same time. Cutting costs helps entities earn even more money from sales. Still, it can have serious repercussions if expenses are heavily cut.
For instance, expending less on advertising and promotion will reduce costs. However, it will eventually lower the company’s brand visibility and its ability to approach potential customers.
Accounting of Expenses
Business entities give a break up of their revenues and expenses in their statement of profit and loss. They use either cash or accrual basis to record expenses. Under the cash accounting method, the expenses are recorded when actually paid. On the other hand, under the accrual method, expenses are accounted for when the liability arises.
For instance, if a business entity spends on coffee and tea for its employees in the office, it uses cash basis to record the expense when it pays the invoice. Under the accrual method, the accountant would record the staff welfare expense when the business entity receives the service.
Expenses are usually recorded on an accrual basis, securing a match with the revenues recorded in accounting periods. Accordingly, expenses are used to compute the net income. The equation to estimate net income is total revenue minus total expense.
Under the Income Tax Act, businesses are not allowed to claim their personal or non-business expenses as business deductions. They also cannot claim penalties and fines.
Capital expenditure refers to funds utilised by a company to acquire, improve, and maintain fixed physical assets such as property, buildings, an industrial plant, technology, or equipment.