Expense in accounting and budgeting examples defined, explained gas oil ratio formula


Accountants define expense as a decrease in owners equity caused by using up assets. This definition includes cash and non cash expenses. Expenses are center stage in daily operations, budgeting, planning, and financial reporting. What is the Meaning of Expense?

Expense is an accounting and budgeting term used in every-day speech to refer to anything that causes spending. Accountants, however, define expense more broadly and more precisely as follows: An expense is a decrease in owners equity caused by using up assets in producing revenew or in other activities that are part of entity operations.

Spending on employee wages, for instance, is an expense because it uses up cash assets.The broader definition also covers non cash expenses, such as depreciation or bad debt expenses. However, every expense event—cash or non cash—calls for an impact on an expense category account.

Sections below further define, explain, and illustrate expense. Note especially that the term appears in context with related terms and concepts from the fields of budgeting, cost accounting, and financial accounting, including the following:

Expenses impact all of the major financial accounting statements, but especially the Income statement (or Profit and Loss statement, P&L, or Statement of operations). The Income statement reports financial performance for a specific time period. For profit-making companies, of course, the highest level performance measure is profit.

Income statements typically include just one or a very few revenue lines, but many expense lines. Note especially that each expense line represents an expense category account (or group of accounts) from the accounting system’s chart of accounts. What Are the Important Income Statement Expense Headings?

Cost of Goods Sold (COGS or CGS) is the total cost of acquiring raw materials and turning them into finished goods. COGS normally does not include costs which apply to the whole enterprise, or to selling, or administrative expenses. For firms outside the financial industries, COGS also excludes interest expenses and costs due to extraordinary items.

These are costs associated with borrowing or earning income from financial investments. Note that this category exists only for firms that are not in a financial industry. For these firms, therefore, financial expenses are incurred outside the firm’s normal line of business.

Gross profit is the difference between total COGS and Net sales revenues. Gross profit, of course, is an amount, expressed in currency units. Business people often find it helpful to deal instead with Gross margin, which is Gross profit as a percentage of Net Sales.

The high level Income statement shows Gross profit for the entire reporting firm. The firm’s leaders, however, have a keen interest in "drilling down" from the high level figures. They may need especially to uncover actual Gross profits for individual products, services, and product lines. These figures may show, for instance, that some products are very profitable while others are not. This information is crucial for effective product management and product strategy decisions.

To find product Gross profits, the firm can estimate sales revenues, direct materials costs, and direct labor costs rather easily and rather directly. However, it is not always so easy to estimate "indirect" or "overhead" expenses. This is especially true when overhead or indirect activities support multiple products or product lines.

• Actual product overhead expenses can be very uncertain, where firms rely on traditional costing methods. In those cases, reported overhead figures often derive from allocation rules that are somewhat arbitrary. These may or may not reflect actual overhead resource usage for different products.

Besides impacting Gross profit, COGS also impacts Income statement "Profit" results that appear below Gross profit. This means, of course, that Operating profit and Net profit reflect the impact of Cost of goods sold (or Cost of Services, or Cost of Sales). Operating Expenses Impact Profits

These expenses do not impact Income statement Gross profit. This is because they appear below (after) the Gross profit line. For this reason, these expenses are sometimes called "below the line" costs. Operating expenses, however, do impact Operating profit and bottom line Net profit. Financial and Extraordinary Item Expenses Impact Profits

Extraordinary expenses and Financial expenses normally appear below Operating profit on the Income statement. Only when the firm operates in the financial industry, do financial expenses appear higher on the Income statement. For financial firms, these expenses may rightfully appear under "Cost of Services" or "Operating Expenses. Outside the financial industries, of course, these expenses impact only one profit result, bottom line Net profit. What Are Non Cash Expenses?

Non cash expenses are charges against earnings which exist solely for the purpose of reducing Net profit (thereby lowering taxes). They do not represent actual cash flow. Note that non cash expenses are not an Income statement category. They are instead a kind of expense that can appear in any of the major categories above.

Operating expenses (OPEX) represent spending for normal business operations. OPEX may include spending for salaries and wages, insurance, floor space rental, electricity, or maintenance contracts, for instance. In brief, almost all routine expenditures a company makes are operating expenses, except for a few special non-operating costs(such as costs of financing a loan, or one-time costs for closing a plant), and except for capital expenditures.

The term capital expenditure (CAPEX) refers to spending that contributes value to the property and equipment base owned by the business. Capital asset purchases, for instance, are capital expenditures. As a result, these assets become part of the organization’s asset base. Consequently, they contribute to asset accounts on the Balance sheet.

Whether an expenditure qualifies as CAPEX or OPEX depends on what is purchased, the use of the purchase, and also upon the country’s tax laws. As a result, tax paying companies usually define specific criteria, or "rules," that qualify an acquisition as CAPEX. Expenses that do not meet these criteria are, by default, OPEX. Capitalization Criteria

Capitalization, incidentally, can include more than direct item purchases. Note that projects that build capital assets are called capital projects. And, capital projects may include expenses that do not normally qualify as CAPEX, but which do qualify when they are part of a capital project. A a result, capital projects require CAPEX funding.