Expense
Encyclopedia
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 is "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". "Expenses of the table" are expenses of dining, refreshments, a feast
, etc.
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
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 is not an expense.
, 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 is classified as a capital expenditure
or an expenditure subject to depreciation
, which is not an expense. These latter types of expenditures are reported as expenses when they are depreciated by businesses that use accrual-basis accounting, which is most large businesses and all C corporation
s.
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 is usually identified as an expense. If it retains value soon and long after the purchase, it will be viewed as capital with life that should be amortized/depreciated
and retained on the Balance Sheet
.
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 do not 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 have acquired a new business-related asset. This cost could not 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 does not improve or prolong the life of the truck but simply allows the truck to run.
Even if something qualifies as an expense, it is not 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 does not 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 do not 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 are (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 should not report this at all in the income statement, which is what had previously been the norm.
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
to another person or group to pay for an item or service, or for a category of costs. For a tenant
Leasehold estate
A leasehold estate is an ownership of a temporary right to land or property in which a lessee or a tenant holds rights of real property by some form of title from a lessor or landlord....
, rent
Renting
Renting is an agreement where a payment is made for the temporary use of a good, service or property owned by another. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from landowners...
is an expense. For students or parents, tuition
Tuition
Tuition payments, known primarily as tuition in American English and as tuition fees in British English, Canadian English, Australian English, New Zealand English and Indian English, refers to a fee charged for educational instruction during higher education.Tuition payments are charged by...
is an expense. Buying food, clothing, furniture or an automobile is often referred to as an expense. An expense is a cost that is "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". "Expenses of the table" are expenses of dining, refreshments, a feast
Feast
Feast may refer to:* Banquet, a large meal* A Festival or feria* Ramadan, Muslim's holy month* Nineteen Day Feast, a monthly meeting held in Bahá'í communities to worship, consult, and socialize....
, etc.
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
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
is used up or a liability is incurred. In terms of the accounting equation
Accounting equation
The basic accounting equation' is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.In a corporation, capital represents the stockholders' equity.-In practice:...
, expenses reduce owners' equity
Equity (economics)
Equity is the concept or idea of fairness in economics, particularly as to taxation or welfare economics. More specifically it may refer to equal life chances regardless of identity, to provide all citizens with a basic minimum of income/goods/services or to increase funds and commitment for...
. The International Accounting Standards Board
International Accounting Standards Board
The International Accounting Standards Board is an independent, privately funded accounting standard-setter based in London, England.The IASB was founded on April 1, 2001 as the successor to the International Accounting Standards Committee...
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 statementIncome statement
Income statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
account) and a credit to either an asset account or a liability account, which are balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
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 is not an expense.
Cash flow
In a cash flow statementCash flow statement
In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow statement, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing...
, expenditures are divided into operating, investing, and financing expenditures.
- Operational expenseOperating expenseAn operating expense, operating expenditure, operational expense, operational expenditure or OPEX is an ongoing cost for running a product, business, or system . Its counterpart, a capital expenditure , is the cost of developing or providing non-consumable parts for the product or system...
– salary for employees - Capital expenditureCapital expenditureCapital expenditures are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing fixed asset with a useful life extending beyond the taxable year...
– buying equipment - Financing expenseCorporate financeCorporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the firm's financial risks...
– interest expenseInterest expenseInterest expense relates to the cost of borrowing money. It is the price that a lender charges a borrower for the use of the lender's money. Interest expense is different from OPEX and CAPEX, for it relates to the capital structure of a company. Interest expense is usually tax-deductible....
for loans and bondsBond (finance)In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
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
Income statement
Income statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
; or whether it is classified as a capital expenditure
Capital expenditure
Capital expenditures are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing fixed asset with a useful life extending beyond the taxable year...
or an expenditure subject to depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
, which is not an expense. These latter types of expenditures are reported as expenses when they are depreciated by businesses that use accrual-basis accounting, which is most large businesses and all C corporation
C corporation
C corporation refers to any corporation that, under United States income tax law, is taxed separately from its owners. It is distinguished from an S corporation, which is not taxed separately. Most major companies are treated as C corporations for U.S. income tax purposes.-C corporation vs...
s.
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 is usually identified as an expense. If it retains value soon and long after the purchase, it will be viewed as capital with life that should be amortized/depreciated
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
and retained on the Balance Sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
.
Deduction of business expenses under the United States tax code
For tax purposes, the Internal Revenue CodeInternal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States 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 do not 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 have acquired a new business-related asset. This cost could not 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 does not improve or prolong the life of the truck but simply allows the truck to run.
Even if something qualifies as an expense, it is not 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 does not 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 do not 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 are (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
Controversy
Controversy is a state of prolonged public dispute or debate, usually concerning a matter of opinion. The word was coined from the Latin controversia, as a composite of controversus – "turned in an opposite direction," from contra – "against" – and vertere – to turn, or versus , hence, "to turn...
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
Income statement
Income statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
, or should not report this at all in the income statement, which is what had previously been the norm.
Expense Report
An expense report is a form of document that contains all the expenses that an individual has incurred as a result of the business operation. For example, if the owner of a business travels to another location for a meeting, the cost of travel, the meals, and all other expenses that he/she has incurred may be added to the expense report. Consequently, these expenses will be considered business expenses and are tax deductible.See also
- Cash flow statementCash flow statementIn financial accounting, a cash flow statement, also known as statement of cash flows or funds flow statement, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing...
- Income statementIncome statementIncome statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
- Balance SheetBalance sheetIn financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
- Capital Expenditures
- AmortizationAmortization (business)In business, amortization refers to spreading payments over multiple periods. The term is used for two separate processes: amortization of loans and amortization of intangible assets.-Amortization of loans:...
/ DepreciationDepreciationDepreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used .... - Stock Option ExpensingStock option expensingStock option expensing is a method of accounting for the value of share options, distributed as incentives to employees, within the profit and loss reporting of a listed business....
- Operational ExpenditureOperating expenseAn operating expense, operating expenditure, operational expense, operational expenditure or OPEX is an ongoing cost for running a product, business, or system . Its counterpart, a capital expenditure , is the cost of developing or providing non-consumable parts for the product or system...
- Non-Cash Expense
- Expenses versus Capital ExpendituresExpenses versus Capital ExpendituresUnder United States income tax law, to make a deduction in the current taxable year, a taxpayer must be able to show that a particular cost is a business expense and not a capital expenditure...