An expense is a cost that occurs as part of the operating activities of a company during a specific accounting period. According to the accrual accounting method, an expense is reported in the income statement for the period when: the cost better matches the related income, the cost is exhausted or expires, or there is uncertainty or difficulty in measuring the future cost benefit.
For example, when preparing a retailer's income statement for the month of August, the cost of goods that were sold in that month should be reported. (The date the retailer paid for the goods is not relevant.) The commissions that sales staff earnfor having sold the goods in August they must be reported as an expense in the August income statement (even if the commissions are paid in September). The cost of electricity used in month eight must also be included as an expense in that month's income statement (even if the bill is received in September and paid in October). These examples indicate that an expense may occur in an accounting period that is different from the period that the business pays for the item. Therefore, the word expense has a meaning that is different from payment.
Expenses are often divided into two main classifications: operational and non-operational.
Operating expenses involve the main activities of a company. For example, a retailer's operating expenses include: cost of goods sold, and selling, general and administrative (SG&A) expenses. The company can sort these expenses by department, product line, branch, etc.
The non-operating expenses of a retailer refer to its incidental activities. A common non-operating expense for a retailer is interest expense.
The expense account is a counter equity account that has a debit balance. This means that equity is reduced as the business generates more expenses. This makes sense since expenses decrease the company's net income or profit. You can see this clearly in the expanded accounting equation where:
Equity = owner's equity - withdrawals + income - expenses.
As the expense account increases, the total capital of the company decreases.
