Expense accounting involves the proper recognition and recordation of a consumed expenditure or an incurred obligation. This process is critical to recognizing expenses in the correct amount and reporting period. The following activities are needed in expense accounting:
Consumed Expenditures - Occurs when a supplier invoice is received or cash payment made in exchange for goods or services.
- Decide whether the amount is to be treated as an expense or asset. If the item can be consumed over multiple periods, it is likely to be treated as an asset.
- If an expense, recognize it within the correct expense account, such as direct materials, supplies, or utilities.
- If an asset, record it in either the prepaid expenses account (for short-term assets) or a fixed assets account (for longer-term assets).
- If a prepaid expense, monitor it each month and charge it to expense as consumed.
- If a fixed asset, charge a consistent portion of it to depreciation expense in each month, until it is fully consumed.
- If no invoice has been received or payment made, there may still be an obligation to pay a supplier. If so, create a reversing journal entry that records an accrued expense in the current period, and reverses it in the next period. Doing so ensures that the expense is recognized in the correct period. When the invoice is received or payment made in the next period, it offsets the reversal, resulting in no net entry in the following period.
Incurred Obligations - Occurs when a business takes on an obligation to pay a third party.
- Decide whether there is a probable obligation and the amount can be clearly determined. If so, record a liability. The offset to the liability is a charge to expense.
- Review the obligation in later periods to see if the amount has changed. If so, adjust the liability and the offsetting expense.
The expense accounting noted here is used in an accrual basis accounting system.