Expenses are the costs a business, household or other organisation incurs in the course of its activities, such as wages, rent, materials, interest and the wearing out of equipment. In accounting, expenses are the decreases in economic benefits during a period that reduce owners' equity, other than distributions to the owners themselves. In personal finance, the word simply means money spent on living costs.
Expenses are the counterpart of revenue: revenue minus expenses gives profit, reported as net income at the bottom of the income statement. The term overlaps with "costs" and "expenditure" but is not identical: buying a machine is an expenditure, yet it becomes an expense only gradually as the machine is used up. For businesses, the rules on when to record an expense come from accounting standards (IFRS internationally, US GAAP in the United States), and tax law decides separately which expenses can be deducted.
Expenses in plain terms
Picture a food stall at a weekend market. The money customers hand over is revenue. Everything the owner has to pay to keep the stall running (ingredients, the pitch fee, the helper's pay, the gas for the stove) is an expense. Whatever is left in the tin after those are covered is the owner's profit for the weekend.
The tricky part is timing. If the owner buys a new grill that will last five years, it would be odd to say the whole cost belongs to one weekend. Accountants spread it across the weekends it is used. Likewise, if the pitch fee for next month is paid today, it belongs to next month. Expenses are matched to the period that benefits, not simply to the day cash leaves the tin.
How expenses are recognised
Under accrual accounting, used by almost all companies of any size, an expense is recorded when the cost is incurred, whether or not cash has been paid. The IASB's 2018 Conceptual Framework defines expenses as decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to equity holders. Three practical consequences follow:
- Costs paid in advance, such as a year's insurance, are first held as an asset called prepaid expenses and released to expense month by month.
- Costs incurred but not yet paid, such as a supplier's invoice, are expensed now and owed through accounts payable.
- Long-lived assets are expensed over their useful lives through depreciation (physical assets) and amortization (intangible assets).
Small businesses and individuals often use cash accounting instead, recording an expense only when it is paid. It is simpler but can distort results when large bills fall in a different month from the work they relate to. The matching of expenses to related income also mirrors the timing rules for revenue recognition.
Recording an expense: a worked example
In double-entry accounting, every expense is a debit to an expense account with a matching credit elsewhere. Suppose a firm pays $1,200 on 1 January for twelve months of insurance. The first journal entry records an asset, not an expense:
| Date | Account | Debit | Credit |
|---|---|---|---|
| 1 Jan | Prepaid insurance (asset) | $1,200 | |
| 1 Jan | Cash | $1,200 | |
| 31 Jan | Insurance expense | $100 | |
| 31 Jan | Prepaid insurance (asset) | $100 |
Each month-end repeats the second pair of lines, so the income statement shows $100 of insurance expense in each of the twelve months, and the prepaid balance falls to zero by December.
Types and classifications
Expenses are grouped in several overlapping ways, depending on who is asking:
- By behaviour. Fixed costs such as rent stay the same as output changes, while variable costs such as raw materials rise and fall with volume. In household budgeting the same split appears as fixed expenses and variable expenses.
- By function. Cost of sales, selling and distribution, and administrative expenses, a layout common on income statements.
- By nature. Employee costs, materials, depreciation and similar natural categories. IFRS allows either function or nature, with extra disclosure when function is used.
- Operating and non-operating. Operating expenses relate to the core business; interest on borrowings and one-off losses are usually shown separately. IFRS 18, effective for periods beginning on or after 1 January 2027, introduces defined operating, investing and financing categories in the income statement.
Investment funds report their running costs as a percentage of assets through the expense ratio.
Expenses and tax
Tax rules decide which accounting expenses reduce taxable profit. In the United States, section 162 of the Internal Revenue Code allows a deduction for ordinary and necessary expenses paid or incurred in carrying on a trade or business; personal, living and family costs are generally not deductible. Other countries apply similar "wholly and exclusively" or business-purpose tests, and most disallow fines, many entertainment costs and expenses without proper records. Because tax depreciation schedules often differ from accounting depreciation, a company's taxable profit and its reported profit rarely match exactly. For individuals, tracking expenses is the core of any budget.