Accountancy Expense Accounts, Expense Accounts Accounting, Expense Expenditures
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In accounting, Expense has a very specific meaning. It is an outflow of cash or other valuable assets from a person or company to another person or company.
In common usage, Expense Accounts or expenditures are an outflow of money to another person or group to pay for an item or service, or for a category of costs.
For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often referred to as an expense.
Each account in the Anglo-Saxon chart is classified into one of the five categories:
Assets, Liabilities, Equity, Income and Expenses.
A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger.
An Expense is a cost that is "paid" or "remitted", usually in exchange for
something of value. Something that seems to cost a great deal is "expensive". Something
that seems to cost little is "inexpensive".
In accounting, Expense has a very specific meaning. It is an outflow of cash or other valuable assets from a person or company to another person or company. This outflow of cash is generally one side of a trade for products or services that have equal or better current or future value to the buyer than to the seller.
Technically, an expense is an event in which an asset is used up or a liability is incurred. In terms of the accounting equation, expenses reduce owners' equity.
The International Accounting Standards Board defines expenses as:
...decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Bookkeeping for Expenses
Double-Entry Bookkeeping System, expenses are recorded as a debit
to an expense account (an income statement account) and a credit to either
an asset account or a liability account, which are balance sheet accounts.
An expense decreases assets or increases liabilities. Typical business expenses include salaries, utilities, depreciation of capital assets, and interest expense for loans. The purchase of a capital asset such as a building or equipment is not an expense.
In a cash flow statement, expenditures are divided into operating, investing, and financing expenditures:
- Operational expense (OPEX)—salary for employees.
- Capital expenditure (CAPEX)—buying equipment.
- Financing expense—interest expense for loans and bonds.
An important issue in accounting is whether a particular expenditure is classified
as an expense, which is reported immediately on the business's income statement;
or whether it is classified as a capital expenditure or an expenditure subject to
depreciation, which is not an expense.
These latter types of expenditures are reported as expenses when they are depreciated by businesses that use accrual-basis accounting, which is most large businesses and all 'C' corporations.
The most common interpretation of whether an expense is of capital or income variety depends upon its term. Viewing an expense as a purchase helps alleviate this distinction. If, soon after the "purchase", that which was expensed holds no value then it is usually identified as an expense. If it retains value soon and long after the purchase, it will be viewed as capital with life that should be amortized/depreciated and retained on the Balance Sheet.
For tax purposes, the Internal Revenue Code permits the deduction of business expenses
in the taxable year in which those expenses are paid or incurred. This is
in contrast to capital expenditures that are paid or incurred to acquire an asset.
Expenses are costs that do not acquire, improve, or prolong the life of an
asset. For example, a person who buys a new truck for a business would be
making a capital expenditure because they have acquired a new business-related asset.
This cost could not be deducted in the current taxable year. However, the gas the person buys during that year to fuel that truck would be considered a deductible expense. The cost of purchasing gas does not improve or prolong the life of the truck but simply allows the truck to run.
Even if something qualifies as an expense, it is not necessarily deductible. As a general rule, expenses are deductible if they relate to a taxpayer's trade or business activity or if the expense is paid or incurred in the production or collection of income from an activity that does not rise to the level of a trade or business (investment activity).
Section 162(a) of the US Internal Revenue Code is the deduction provision for business or trade expenses. In order to be a trade or business expense and qualify for a deduction, it must satisfy 5 elements in addition to qualifying as an expense. It must be (1) ordinary and (2) necessary (Welch v. Helvering, 290 U.S. 111, defines this as necessary for the development of the business at least in that they were appropriate and helpful).
Expenses paid to preserve one's reputation do not appear to qualify (Welch v. Helvering). In addition, it must be (3) paid or incurred during the taxable year. It must be paid (4) in carrying on (meaning not prior to the start of a business or in creating it) (5) a trade or business activity. To qualify as a trade or business activity, it must be continuous and regular, and profit must be the primary motive.
Section 212 of the Internal Revenue Code is the deduction provision for investment expenses. In addition to being an expense and satisfying elements 1-4 above, expenses are deductible as an investment activity under Section 212 of the Internal Revenue Code if they are (1) for the production or collection of income, (2) for the management, conservation, or maintenance of property held for the production of income, or (3) in connection with the determination, collection, or refund of any tax.
In investing, one controversy that mounted throughout 2002 and 2003 was whether companies should report the granting of stock options to employees as an expense on the income statement, or should not report this at all in the income statement, which is what had previously been the norm.
Some tips on how to avoid business failure:
- Don't underestimate the capital you need to start up the business.
- Understand and keep control of your finances - income earned is not the same as
cash in hand.
- More volume does not automatically mean more profit - you need to get your pricing
- Make sure you have good software for your business, software that provides you with a good reporting picture of all aspects of your business operations.
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