When you run a business, you are drowned in daily transactions that can leave you wondering which account isn’t an expense account. From buying equipment to SaaS subscriptions to paying rent and salaries, there are countless expenses to record.
Confusion about expense and non-expense accounts leads to botched-up financial statements and bad business decisions.
In this guide, we identify the differences between expense and non-expense accounts, understand the implications of misclassifying them, and discuss common mistakes.
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What is an Expense Account?
An expense account is a record of a company’s daily business expenses during a monthly, quarterly, or yearly accounting period. These expenses are used up during this period to generate revenue — for example, office supplies or rent.
At the end of every accounting period, the expense account is closed to clearly align expenses to the period in which they were used up. That’s why the account classification of expense accounts is temporary.
An expense account debit or credit depends on whether there is a cash inflow or outflow. Such accounts increase with a debit when cash flows out and decrease with a credit when cash flows in.
These are recorded in detail in a company’s profit and loss (P&L) or income statement, showing their impact on the bottom line.
Why Misclassifying Accounts Causes Problems
We have just had a glimpse of what an expense account is. Let’s look at the hazards of misclassifying them.
A company’s operational expenses are recorded under different headings. For example, it could be a travel, training, or utilities expense. If these are all lumped together in a general ledger under a broad expenses account, it’s difficult to track the cost of each item.
Without knowing exactly where the money is being spent, it’s impossible to identify cost-reduction or reallocation opportunities. For example, if marketing expenses are booked under selling expenses, it fails to differentiate between departmental functions, resulting in faulty budgeting.
Moreover, distorted finance metrics mislead owners and stakeholders into believing that the company is making more (or less) profit, which can lead to poor decision-making. This impacts financial planning and ultimately the company’s profit margin.
Lastly, misclassifying accounts can lead to audit and tax issues, creating unnecessary problems. In fact, classifying accounts correctly helps identify tax-deductible expenses.
That’s why, to generate meaningful financial statements and reports for internal and tax purposes, direct the course of the business, and set a realistic budget, it’s important to classify accounts correctly.
What Counts as an Expense Account
At this point, a host of company expenses might be crowding your mind. It’s important to clearly define what constitutes an expense account to avoid any confusion.
The most common types of expense accounts are:
- HR Expenses: Salaries, wages, bonuses, and payroll taxes are included here.
- G&A Expenses: General and administrative expenses count in corporate tax, insurance, and office supplies.
- Marketing and Advertising Expenses: Advertising and marketing efforts to attract and convert leads to customers are included here.
- Selling Expenses: Costs of conducting trade shows, sales commissions, and any expenses on clients are part of this category of expense account.
- R&D Expenses: To develop prototypes and conduct research and pilot projects, R&D expenses incurred fall under this category.
- Cost of Goods Sold (COGS): Any expenses contributing directly to the production of the product or service are considered COGS. E.g., raw materials and direct labor.
- Travel and Entertainment Expenses: Transportation, travel allowance, daily allowance, and hotel expenses come under this heading.
- Financial Expenses: Interest expenses, bank charges, and credit card fees fall in this category.
- Professional Services Expense: This heading includes headhunting, bookkeeping, and legal service fees.
- Tax Expenses: Property, income, and sales taxes are part of the expenses account.
- Repair and Maintenance Fees: Machine, equipment, and building repair and maintenance fees are included here.
- Amortization and Depreciation Expenses: Both physical and intangible assets of a company that gradually lose their value over time are recorded as expense accounts.
- Non-operating Expenses: Expenses incurred due to unexpected circumstances, such as natural disasters, interest on loans, and losses from investments, are included here.
- Miscellaneous Expenses: Corporate social responsibility, charity, and bad debts fall under this heading.
Is Cost of Goods Sold an Expense Account?
To reiterate, yes, the cost of goods sold is an expense account. Direct costs that are needed to produce goods and services, like manufacturing overhead, cost of raw materials, and cost of labor, are included in COGS.
For manufacturing companies, it’s simply called COGS. For a service company, the term “cost of services” is used instead of COGS.
Businesses that sell both products and services use “cost of sales” instead of COGS.
Which is Not an Expense Account?
So, the next question that arises is which is not an expense account. Just remember that assets, liabilities, and owner’s equity accounts are not expense accounts.
The purchase of assets such as land, buildings, furniture, vehicles, and equipment is not an expense account. These are capital expenditures that are not used up during an accounting period and have long-term value.
If you’re wondering if accounts payable is an expense account, the answer is no. Accounts payable, loan payments, taxes, and credit card payments are liabilities. Whatever the company owes to another party and pays back is not an expense account.
Equity accounts refer to the business owners’ accounts, and they may draw, add to, close, or take dividends from this account, which is not an expense account.
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How to Correctly Identify Expense vs. Non-Expense Accounts
At the most basic level, any cash that goes out automatically registers in our mind as an expense. But as we have just seen above, not all cash outflows are expenses.
To correctly identify expense vs. non-expense accounts, ask yourself whether the expense will affect the business only in the current month or over a few years.
Expense accounts are short-term and immediate. They help with the daily running of the business.
Any expenditure that will affect the company for a few years is a non-expense account. The land or building a company owns will have more economic value in the future. So, it’s a non-expense account.
Another question to ask is whether the expense is having an immediate impact on profit. Expense accounts do, while non-expense accounts don’t.
Common Mistakes You Should Avoid
You must have figured out by now that one of the most common mistakes is putting an expense account under a non-expense one and vice versa.
Here is a list of some of the common mistakes:
- Confusion between long-term and short-term purchases: Purchases like buildings, vehicles, equipment, and even long-term SaaS subscriptions are assets that bring value to your business over a few years. Therefore, they are non-expense accounts.
- Classify loan payments as expenses: A loan payment is not an expense account because you are paying back something you borrowed for your business.Only the interest amount of the loan is an expense account. The principal loan amount is a non-expense account, which does not affect the bottom line. Always categorize your loan payment under loan interest and loan principal for error-free bookkeeping.Keep a monthly bookkeeping checklist handy to stay on top of your finances.
- Record inventory as an expense account: When we talk about what is not an expense account, inventory is included in it. Like land and buildings, inventory is an asset, and asset accounts are not expense accounts.
- Record owner withdrawals as expenses: Owner withdrawals affect the equity accounts, which are not expense accounts. Plus, these withdrawals do not affect the company’s profit.
- Confusion between prepaid and immediate expenses: Prepaid expenses, like rent or insurance, are assets until the portions are used up during the accounting period. Only the used-up portions are accounted for as expenses as and when they take place.
- Booking tax payments as OpEx: Sales, payroll, and income taxes are not part of the daily expenses for running the business. They should be booked under a separate tax expenses heading.
- Confuse capital improvements with repairs: Any expenses spent on improving the value of buildings or machinery are not a repair expense. Whatever improves the value is an asset, and whatever is spent on repairs is an expense.
Frequently Asked Questions (FAQs)
The following are some frequently asked questions about non-expense and expense accounts:
What is the Difference Between Expense and Expenditure?
An expense is a cost required for running business operations. It recurs regularly, is directly related to running the day-to-day business activities, and has an impact on the company’s profit or bottom line. E.g., rent, utilities, office supplies. It’s recorded in the income statement.
Expenditure is money spent on purchasing goods and services for both long-term and short-term requirements. It may be recurring or one-time and does not have an immediate effect on profit. E.g., capital expenditure. Expenditure is reflected in both the P&L and balance sheet.
Can Expense Accounts Be Negative?
Yes, expense accounts can be negative when you credit an expense account. Refunds, discounts, and corrected earlier entries are counted as negative expenses. E.g., a $100 refund from a vendor can be recorded as a negative expense, reducing the total expenses.
What Documentation Supports Expense Entries?
Documents that support expense entries include receipts, purchase orders, invoices, bills, credit cards, and bank statements.
How Often Should Businesses Review Expense Accounts?
It’s a good practice to review expense accounts monthly, quarterly, and annually to identify trends and patterns that emerge over these time periods. This shows the seasonality of the product or service and can help in budgeting for future periods.
Small businesses, especially SaaS businesses, should review their expense accounts weekly as they have shorter business cycles. It helps identify spending and revenue trends, guiding their budgeting and business strategy in the right direction.
Conclusion
It can be a bit tricky to tell which account is not an expense account. The thumb rule is to ask yourself whether the expense is for long-term business benefits or for daily operations. Long-term expenses are assets that are depreciated or amortized.
Short-term, daily operational expenses are, well, expenses. They have a direct influence on the bottom line, whereas the impact of long-term capital expenses is indirect and spread over a longer period.
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