Did you know that when money goes out of a bank account (through expenditure), it’s not always for an expense? This post will help you understand once and for all what an expense is in accounting and make its meaning easy to understand. Remember, expense does not always = money.
If you don’t want to read on, here’s a quick video that you can watch that helps explain what an expense is, how it’s different from expenditure and what counts as an expense.
Expenditure is when someone spends money and while expenses can be a type of expenditure, expenses can happen without the direct spending of money at a particular time.
An expense is in its technical meaning, “is the reduction in value of an asset as it is used to generate revenue” (Source: https://www.accountingtools.com/articles/2017/5/6/expense). But this definition or meaning sounds confusing right?
The easiest way to understand this is through examples.
1. Expense when Money Hasn’t Yet been Paid
Let’s say you own a coffee shop and you run this coffee shop out of a building and you agree to pay $100 every Friday for use of the building. Most people would recognize this as being rent.
This $100 a week is something you owe and is a cost to the business. It is an expense because it will reduce the value of cash, an asset that you own in the business. And the rent is used to generate money in the business (you need a place to make and sell the coffee).
Even if you don’t pay in cold hard cash… the $100 is an expense because you used up the rent for that week, even if you haven’t paid it yet.
2. Expense After Money Has Been Paid but Doesn’t Involve Cash Directly
There are times when expenses don’t involve cash directly.
A common example is depreciation.
You can checkout the video for depreciation below but essentially, when you own something (that you’ve paid for), like a truck - you use that truck for work.
That truck, like your cash, is something you own.
When you reduce the value of that truck through depreciation, you record an amount that would go as an expense called depreciation expense, and reduce the value of the truck as a whole.
For example, let’s say you bought your truck a year ago for $1000.
After a year, the truck loses its value (you can’t sell it for the same amount you bought it) because of use and wear and tear and it being ‘second hand’, so you record depreciation expense of $200 (20% of its original value).
So…going back to that dictionary meaning, “reduction in value of an asset used to generate revenue”. Your truck helped you generate revenue if you’re using it in business and you reduced its value.
3. Expenditure isn’t Expense
Lastly, not everything that is spent in your business is an expense.
Just assume you go out and use you cash to buy a van to use in your business. First, there’s been a reduction in cash so you can buy yourself a van.
That van is something you own.
You can keep it and sell it later on. Your asset of cash goes down and your asset of a van goes up.
So you’ve spent (expenditure) to purchase an asset, not spent for an expense.
When that van decreases in value through depreciation, then it’s an expense.
So remember, an expense is a reduction in value of an asset (be it cash, a truck etc…) for the purpose of generating money in a business.
Next: Depreciation definition explained