Expense is the cost of providing goods and services. In accounting, it represents an outflow of resources from a company during an accounting period. That includes purchasing raw materials, paying rent, wage labor, depreciation, and marketing and administrative expenses.
Remember. The expense is not the same as the cash outflow. In accrual accounting, companies may have bought and received goods or services from suppliers, but have not paid them. Thus, there is no cash outflow from the company.
What are the types of expenses in a financial statement?
Running a business involves various expenses. And because of that, in a financial statement, accountants will usually classify them into several categories. They include:
- Cost of goods sold (COGS)
- Selling, general and administrative expenses (SG&A expenses)
- Depreciation expense
- Amortization expense
- Interest expense
- Tax expense
Companies may classify them by the nature of expenses or by function. For example, manufacturers classify depreciation expenses into administrative expense accounts. But, when the company presents depreciation (along with the burden of raw materials and labor) to the cost of goods sold account, that is grouping by function.
Two other classifications you also need to know, namely operational and non-operational expenses. Operating expenses are the sum of the cost of goods sold, selling, general and administrative expenses, depreciation, and amortization expenses. Meanwhile, non-operational include other than them.
Knowing the operational burden is essential. You need it to calculate operating profit, that is, the profit that the company gets from its primary activity. Ideally, the company should generate most of the profits from operations. If not, the company may have to sell its assets to pay interest and pay off debt.
How to recognize expenses in financial statements?
Two accounting methods for recognizing expenses, namely the cash method and the accrual method.
The cash method recognizes an expense when a company pays cash. Let’s take a case. On March 15, the company paid Rp100 to the supplier for the shipment of goods in April. At the end of March, the company recognized it as an expense, even yet received the goods.
The cash method is in contrast to the accrual method. In the accrual method, the recognition of expenses is independent of the flow of money. The company reports expenses in the income statement when they incur, even though they have not paid. In the example above, in March, the company unrecognize an expense as it had not yet received the goods. Instead, the company will record it in April.
The accrual concept raises two main accounts that you need to look at when analyzing a financial statement. They are prepaid expenses and accrued expenses.
The company reports prepaid expense when it has paid cash but has not yet received goods or services. The above case is an example. At the end of March, the company recorded the prepaid expense of Rp100 in the current assets section. Because cash is also decreased at the same nominal, total assets do not change, and the accounting equation remains balanced.
Furthermore, in April, the company has received goods from suppliers. In the financial statements, the company eliminates the prepaid expense account (total assets reduced by Rp100). At the same time, it recognized an expense on the income statement (shareholder equity decreased by Rp100).
The company presents the accrued expense report in the liability section. This account appears when the company has received goods or services from suppliers but has not yet paid for them. So, the company has an obligation to pay it.
As long as they have not paid, the company will record the accrued expenses in the liability section. Also, for the accounting equation to remain balanced, the company records expenses in the income statement. As a result, liabilities go up, and shareholder equity goes down at the same nominal.
After paying suppliers, the company eliminates the accrued expense, reducing total liabilities. At the same time, the company pays cash, so the total assets are reduced by the same amount as the decrease in liabilities.