An expense is the reduction in value of an asset as it is used to generate revenue. If the underlying asset is to be used over a long period of time, the expense takes the form of depreciation, and is charged ratably over the useful life of the asset. If the expense is for an immediately consumed item, such as a salary, then it is usually charged to expense as incurred. Common expenses are:
- Cost of goods sold
- Rent expense
- Wages expense
- Utilities expense
If an expenditure is for a minor amount that may not be consumed for a long period of time, it is usually charged to expense at once, to eliminate the accounting staff time that would otherwise be required to track it as an asset.
Under cash basis accounting, an expense is usually recorded only when a cash payment has been made to a supplier or an employee. Under the accrual basis of accounting, an expense is recorded as noted above, when there is a reduction in the value of an asset, irrespective of any related cash outflow.
The purchase of an asset may be recorded as an expense if the amount paid is less than the capitalization limit used by a company. If the amount paid had been higher than the capitalization limit, then it instead would have been recorded as an asset and charged to expense at a later date, when the asset was consumed.
The accounting for an expense usually involves one of the following transactions:
- Debit to expense, credit to cash. Reflects a cash payment.
- Debit to expense, credit to accounts payable. Reflects a purchase made on credit.
- Debit to expense, credit to asset account. Reflects the charging to expense of an asset, such as depreciation expense on a fixed asset.
- Debit to expense, credit to other liabilities account. Reflects a payment not involving trade payables, such as the interest payment on a loan, or an accrued expense.
Under the matching principle, expenses are typically recognized in the same period in which related revenues are recognized. For example, if goods are sold in January, then both the revenues and cost of goods sold related to the sale transaction should be recorded in January.
An expense is not the same as an expenditure. An expenditure is a payment or the incurrence of a liability, whereas an expense represents the consumption of an asset. Thus, a company could make a $10,000 expenditure of cash for a fixed asset, but the $10,000 asset would only be charged to expense over the term of its useful life. Thus, an expenditure generally occurs up front, while the recognition of an expense might be spread over an extended period of time.
Expense management is the concept of reviewing expenses to determine which ones can be safely reduced or eliminated without having an offsetting negative impact on revenues or on the development of future products or services. Budgets and historical trend analysis are expense management tools.