What are expenses? Understanding the definition and types of expenses

What are expenses?

Simply put, expenses are the expenditures a company makes to maintain its business operations over a given period of time, be it a month, a quarter or a year. In accounting, expenses are often referred to as "charges" or "costs of doing business". Examples include office rent, employee salaries and advertising costs.

Paying these expenses brings short-term benefits, such as increasing employee productivity, keeping operations running smoothly and improving customer service.

Although the terms "expense" and "cost" seem to be interchangeable, they have different meanings in accounting. Costs usually refer to expenditures that result in long-term value or economic benefit, such as the purchase of machinery, vehicles or the construction of buildings.

Expert definitions of expenses

Various experts have shared their definitions of expenses in accounting:

Indonesian Standards of Financial Accounting (SAK): SAK defines expenses as a reduction in economic benefits during an accounting period, typically in the form of outflows or decreased assets or an increase in liabilities that results in a reduction in equity. It is important to note that capital expenditures are not considered expenses.

Sodikin and Riyono (2012): According to these experts, expenses represent cash outflows or decreases in assets or incurrence of liabilities that reduce equity without being associated with distributions to shareholders.

Hanafi and Halim (2009): They describe operating expenses specifically as the consumption of assets or the use of resources — whether internal or by third parties— that result from the company's core business activities.

Kieso et al. (2016): They define expenses as the use of assets or the assumption of liabilities to enable a company's operating activities.

How are expenses recorded in the financial statements?

In the general ledger, expense accounts usually have a debit balance. When expenses increase, they are recorded on the debit side, and when they decrease, they are recorded on the credit side.

In the financial statements, expenses appear in the income statement. At the end of the accounting period, the company's profit or loss is calculated by subtracting the total expenses from the revenue.

Why is expense management so important for Businesses?

Expenses are essential to running a business, but expense mismanagement can jeopardize long-term success. If you save too much, your business operations could be affected. But if you spend too much, your financial health could be in danger.

That’s why effective expense management is so important. Expense management involves scrutinizing, categorizing and analyzing both current and past expenses. It ensures that every penny spent has a positive impact on the financial health and growth of your business.

If expenses are not managed efficiently, it can affect the financial well-being of your business. Here’s what good expense management can do for your business:

1. Financial stability: Thoughtful expense management ensures that you can control your spending and maintain financial stability, even during market turbulence such as declining sales or rising raw material costs.
2. Controlled spending: By establishing clear procedures and budget limits, you can keep your spending under control and reduce the risk of overspending, waste or fraud. The introduction of spending limits for company cards and the requirement for receipts for every transaction increase accountability.
3. Efficient resource allocation: By carefully identifying and managing expenses, you can allocate more resources to areas or business activities that increase profitability while limiting less effective spending.

Types of expenses

In accounting, expenses can be categorized according to their nature and purpose. Here are some important types:

1. Operating expenses: costs that are necessary for day-to-day business operations, such as utilities, rent and building maintenance.
2. Non-operating expenses: These are occasional expenses that are not related to the core business, such as donations or event sponsorships.
3. Cost of goods sold (COGS): Direct costs incurred in the production of goods or services, such as raw materials and direct labor costs.
4. Fixed expenses: Regular, unchanging expenses, such as rent or insurance, that are not influenced by production or sales.
5. Variable expenses: These expenses fluctuate with production or turnover, such as distribution costs or sales commissions.
6. Accrued expenses: Expenses that have already been incurred but not yet paid at the time the annual financial statements are prepared.
7. Bad debt expenses: Expenses incurred as a result of bad debts.
8. Depreciation costs: Expenses in connection with the depreciation of fixed assets such as buildings or machinery.
9. Prepaid expenses: Expenditures paid in advance, the benefit of which occurs in the future, such as annual insurance premiums.
10. Extraordinary expenses: Expenses incurred due to unexpected events such as natural disasters or regulatory changes.

Key performance indicators (KPIs) for expense management

Various key performance indicators can be used to assess how well your company is managing its expenses:

1. Budget variance: This compares actual spend with budgeted amounts to identify discrepancies and understand the reasons behind them.
2. Cost-to-income ratio: This key figure measures the proportion of expenses in relation to the company's revenue and helps to determine whether expenditure is efficient.
3. Return on Investment (ROI): ROI measures the financial return on investment, establishes a link between spending and financial results, and allows companies to evaluate the effectiveness of their spending.
4. Spend category analysis: By categorizing spending, you can identify areas where costs are high or increasing rapidly and make targeted adjustments.
5. Benchmarking: Compare your company’s spend against industry standards or competitors to highlight areas that may need attention.

Manage your expenses more effectively with Aspire

Expense management is the backbone of a sustainable business. With Aspire’s Expense Management solution, you can monitor your company’s spending from a single dashboard. With Aspire, you can set budgets, monitor spending in real-time and ensure that every expense is aligned with your organization’s goals.

Aspire also simplifies financial reporting by integrating with accounting software. This makes it easier to manage company finances without losing focus on other important business activities.

Want to find out more about how Aspire can help your business? Get in touch with our team today!