Starting out, you may categorize all monies spent in running your business under the general umbrella of “expenses”.
Yes, they are expenses, but in accounting, there are different types of expenses.
Knowing these types of expenses would help you in the preparation of sound financial statements and this is what you will learn the different types of expenses in accounting from reading this post.
Type Of Expenses
The following are the type of expenses that exist:
- Selling and Distribution Expenses
- Administrative expenses
- Depreciation expenses
- Cost of sales
- Maintenance and Repairs
- Entertainment Expenses
- Interest (Finance Cost)
- Amortization expenses
- General expenses
- Insurance cost
- Travelling and transportation
- Impairment losses
- Cost of Research and Development
- Printing and Stationery Expenses
- Bad debt
- Private drawings
- Miscellaneous expenses
- Professional fees
Selling And Distribution Expenses:
This type of expense in accounting covers expenses incurred in stimulating demand, driving sales and making goods and services available to the consumers. Examples of selling and distribution expenses are:
- Cost of warehousing and storage
- Commission on Sales
- Advertising, Promotion and, Marketing expenses (whenever these expenses amount to a significant figure, accounting professionals are of the opinion that they are better recognized as a line item in the income statement)
- Cost of transportation
- Royalties on sales
- Cost of fueling distribution vehicles
- Salaries and wages of staff working in the sales and distribution department.
- Discounts, Coupons, and Free Gifts
- Market research expenses
- Cost of packing
General and Administrative Expenses:
These are the type of expenses that are incurred in the day-to-day running of the business. These expenses cannot be pegged to any of the business functions, sales, production, or marketing. Examples of expenses that fall under this category are Office cleaning, Salaries and Benefits of business executives, and other operating expenses.
Depreciation is another type of expense in accounting but it is a notional expense as it does not involve the actual outflow of money from your business. It is simply a systematic reduction in the value of a non-current asset until it becomes zero. Examples of assets that are depreciable are Motor vehicles, buildings, furniture, and so on.
There are different accounting methods for calculating depreciation, some of the most common ones are the Straight Line Method, Reducing Balance Method etcetera.
Here is an example of depreciation:
Assuming your business purchase a Motor Vehicle whose estimated useful life is 5 years for N500,000. The scrap value is estimated to be N130,000 Using the SLM method, the yearly depreciation would be:
Depreciation = Cost – Scrap value/ useful life
= N500,000-N130,000/5 = 74,000 per annum.
Cost Of Sales:
This is the first type of expense in accounting that is recognized in the income statement. It is the cost of goods that is sold in a particular accounting period, and it is deducted from the revenue generated in the same period to realize the gross profit.
Cost of Sales = Opening Inventory + Purchases – Closing Inventory.
The aforementioned is for a retail business. If your business is in the manufacturing space you’ll have to consider the opening, purchases and closing inventory of Direct Raw Materials, Work-In-Progress and Finished Goods, the direct expenses, and direct labour to get the cost of sales incurred.
Maintenance And Repairs:
To keep assets in optimal working condition, they must undergo regular repairs and maintenance. Depending on where the asset is being utilized, these expenses can be categorized as selling and distribution expenses, general expenses.
This covers the cost of entertaining guests who visit your entity. Feeding, drinking, relaxation and other related costs can be categorized here.
Rent is paid for the use of any property. It could be monthly, quarterly or paid per annum. However, rent expenses are recognized in full as a line item in the income statement for the accounting period in which you leased the property.
Provisions are monies set aside to cover probable future expenses. Examples of provisions are provisions for doubtful debt, provisions for bad debt.
Provisions are not expenses that have actually been incurred but they help to cover for expenses that are reasonably expected to happen.
Provisions are estimates and eventually, the actual money that’d be required may be lesser or higher than the amount initially set aside.
Examples of this type of expenses in accounting are electricity, water, gas, generator, and so on.
Finance costs such as Interest in Bank loans, Debentures or Preference Shares are deducted from Operating Profit to get your Profit Before Tax.
Operating profit is what remains after deducting all other overheads.
Amortisation is the same as depreciation expenses, the only difference is that while depreciation is charged on tangible assets, amortisation expense is charged on intangible assets like trademarks, patents, brand equity, copyright and so on.
Any premium paid to protect your business against any hazard would be identified as a line item in the income statement. Insurance costs are usually paid in advance, and thus any prepayment would also be recognized as a current asset in the balance sheet.
This is a permanent reduction in the value of an asset. The value of assets should be assessed regularly to determine if they have suffered impairment or not. Land and Intangibles usually impairs.
Note: Land cannot be depreciated. It can only suffer impairment.
Cost Of Research And Development:
If your business invests in research and development to create or improve products and processes, you are eligible to deduct such expenses from your gross profit in the accounting period where you carried out the R&D.
Legal fees, accountancy fees and other fees paid for professional or consultancy services rendered to a business are deducted from the gross profit or total income in the income statement.
Taxation is an expense your business cannot avoid except in cases where you have a tax credit, incurred loss or your business is tax-exempt. For small businesses whose revenue is less than 1 million, the tax rate is 20% for the first 5 years but others pay 30% of their operating profit after deducting all finance cost as tax.
Printing And Stationery Expenses:
This covers the cost of items that are used by the employees in the business for communication. Examples of such items are pens, pencils, staplers, plain papers, letterhead, staplers, envelopes, and so on.
It is important to take note of materiality here:
Let’s assume your business purchases a photocopier and a stapler, both are items of stationery and printing but both won’t be expensed. This is because the cost of a photocopier is substantially significant and can last for many years, hence it’ll be treated as an asset and even though the stapler can also last many years, its cost is not material. Therefore it will be expensed.
This is a type of expense that would arise when your account receivables fail to make payment when due and the debt has gone on for a long time or the debtor is now in a situation where repayment becomes almost impossible. Perhaps he or she goes bankrupt or dies. Whatever the case, you’ll recognize such as bad debt written off.
These are expenses that are not material enough to be a line item in the income statement. Therefore you’ll represent all such expenses as miscellaneous.
Before we call it quits on the types of expenses in accounting, take good note of the information below
Although these are withdrawals from the business by the owner for Personal use yet they are not categorized as normal business expenses. Therefore they do not feature in the income statement. However, they are shown in the cashflow statement and reduce the owner’s equity in the statement of financial position.