Expense - What is an expense?

An expense is defined as an outflow of money or assets to another individual or company as payment for an item or service.

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An expense is a cost experienced by a company, paid out to suppliers or for products or services from other sources. Within a business context, only expenses that relate to the cost of business operations should be included in the company’s records.

As one of the main aspects of running a business, managing expenses is a crucial part of keeping tabs on your company’s financial health. Expenses are ultimately money that is spent in order to ensure the company can function and grow the operations of the business.

Technically speaking, an expense is incurred whenever an asset is used up or a liability is incurred. With regards to the accounting equation, expenses effectively reduce a business owner's equity.

Types of Expenses

Different expenses will be incurred, depending on the nature and size of the business. However, there are some expenses that are common to almost all businesses. These are:

  • Rent expenses - this is rent that is paid on properties or space that is used for business purposes

  • Wage expenses - this refers to any amount of money paid out to employees of a business

  • Interest expenses - this involves the amounts owed on any interest due for small business loans, for example.

While expense tracking might seem tedious, it’s a necessary part of managing the financial side of your business. Thankfully, today it can be done quickly and easily with accounting software.

Recording an expense

Expenses are recorded on the debit side of an expense account (which is an income statement account) and a credit is recorded to either a liability or an asset account in accordance with double-entry bookkeeping.

When the expense is recorded on the profit & loss report is dependent upon the accounting method chosen by a business. Under the accrual method of accounting, an expense is recorded when it’s incurred by a business (which might differ from when cash actually changes hand). Registering expenses under the cash accounting method, however, means that each expense is recorded only when money actually changes hands.

Example of recording an expense with accrual accounting 

In accrual accounting, emphasis is placed on when the business incurs the expense, not when it’s paid. 

For example, a business may pay for internet service in their offices monthly but receive and pay the bill the following month. However, they will record the expense for internet service for the month the cost was incurred, even though payment was made the following month under accrual accounting.

Example of recording an expense with cash accounting

In cash accounting, emphasis is placed on when the transaction takes place, rather than when the expense was incurred. 

For example, a business may pay for electricity quarterly, and receive the bill at the end of each quarter. Although the period covers several months, the amount is only entered into the record at the end of each quarter when the bill is paid.

Expenses you can claim

As a freelancer or small business owner, you can claim certain expenses against tax. In the 2020-2021 tax year, the Personal Allowance in the UK is £12,500. This means that you can offset up to this amount to lower your tax payments. 

Allowable expenses include but are not limited to the following:

  • Cost of office supplies such as paper, pens, ink toner, etc.

  • Travel costs such as mileage, as long as it’s specifically for business operations

  • Costs of running your office, including electricity, internet, heating, etc.

  • Marketing and advertising fees

  • Supplies purchased for resale, such as raw materials.