how expenses are recorded
companies break down their revenues and expenses in their income statements accountants record expenses through one of two accounting methods cash basis or accrual basis under cash basis accounting expenses are recorded when they are paid in contrast under the accrual method expenses are recorded when they are incurred for example if a business owner schedules a carpet cleaner to clean the carpets in the office a company using the cash basis records the expense when it pays the invoice under the accrual method the business accountant would record the carpet cleaning expense when the company receives the service expenses are generally recorded on an accrual basis ensuring that they match up with the revenues reported in accounting periods expenses are used to calculate net income the equation to calculate net income is revenues minus expenses types of business expensesthere are two main categories of business expenses in accounting operating expenses are the expenses related to the company s main activities such as the cost of goods sold administrative fees office supplies direct labor and rent these are the expenses that are incurred from normal day to day activities operating expense is deducted from revenue to arrive at operating income the amount of profit a company earns from its direct business activities companies need to manage their operating expenses to ensure that they are maximizing profits this is usually done by keeping expenses at a minimum however reducing expenses too much can reduce the company s productivity non operating expenses are not directly related to the business s core operations common examples include interest charges and other costs associated with borrowing money these are expenses that occur outside of a company s day to day activities these costs may occur from restructuring reorganizing interest charges on debt or on obsolete inventory non operating expenses are separate from operating expenses from an accounting perspective so as to be able to determine how much a company earns from its core activities special considerationscapital expenditures commonly known as capex are funds used by a company to acquire upgrade and maintain physical assets such as property buildings an industrial plant technology or equipment the irs treats capital expenses differently than most other business expenses while most costs of doing business can be expensed or written off against business income the year they are incurred capital expenses must be capitalized or written off slowly over time 2the irs has a schedule that dictates the portion of a capital asset a business may write off each year until the entire expense is claimed the number of years over which a business writes off a capital expense varies based on the type of asset according to the irs to be deductible a business expense must be both ordinary and necessary ordinary means the expense is common or accepted in that industry while necessary means the expense is helpful in the pursuit of earning income business owners are not allowed to claim their personal non business expenses as business deductions they also cannot claim lobbying expenses penalties and fines 3