As part of OnlineAdvisor’s efforts to educate, inform and encourage business leaders, we present key financial terms and concepts. An important part of financial literacy for a business is the concept of expenses.
What is an Expense?
An expense is a cost a business incurs through its operations. There are all kinds of expenses for businesses. Common business expenses include payments to suppliers, employee wages, rent and leases, and equipment depreciation. Anything that causes cash to leave a business is usually an expense.
The word “expense” is usually a noun. Buying an item is an “expense.” An expense can identify a specific object. An expense can also be a verb, or an action. For example, going out and buying something is an “expense,” too.
Recording an Expense
Accountants record an expense through one of two accounting methods: cash basis or accrual basis.
Under the rules of cash basis accounting, an expense is recorded when it is paid. A company using this method posts the expense when it pays the invoice.
Under the rules of accrual accounting, however, an expense is recorded when it happens. The accountant records the expense when the company receives the service.
The reason why it is important to see the difference is due to timing. Executives working with an accrual method see expenses differently. Expenses post immediately. A small business owner with a cash basis system doesn’t see the expense until he or she writes the check.
There are unique situations that require executives and accountants to pay additional attention to expenses. Included in these situations are capital expenses. Capital expenses are large purchases for a company. Business startup costs, major assets such as real estate, vehicles, equipment and patents, and even big improvements such as building a new wing on a building are capital expenditures.
Rather than writing off these situations right when they happen, business owners divide the value of the total expense over a set number of years. This is an IRS requirement. The number of years over which a business writes off a capital expense is different for the type of asset.