Expense accounting is a crucial component of financial management for any business owner.
This involves tracking all expenses incurred by a business, including the cost of sales and capital expenditures, over a period of time. Doing this helps companies gain valuable insights into their cash flow and net profit, helping them make informed decisions about the future of their company.
Expenses make a mark on financial accounting statements and the balance sheet. Ensuring they are tracked continuously is crucial to ensure better financial performance.
In this article, we will explore the importance of expense accounting in detail, highlighting how it can help business owners to understand their financial situation better and make strategic decisions that will help them achieve long-term success.
What is expense?
In accounting, an expense is a cost obtained by a business for revenue generation or operation maintenance. Cash and non-cash expenses are recorded in a company’s financial statements.
Through these two categories, businesses can track and analyze them better and make precise cost management and optimization decisions.
Expenses are one of the five main groups In a double-entry bookkeeping system.
Other touchpoints include owner’s equity, liabilities, and revenue. Expenses are recorded as a debit to a specific expense account.
Also, Read: Expense vs Expenditure
Types of expenses
Common expense categories
Here are some examples of expenses in accounting:
- Software: Business-related software with SaaS vendors, such as CRM or helpdesk.
- Advertising: These are the costs for advertising or marketing companies to produce promotional materials.
- Credit and collection: Unpaid invoices and fees spent trying to collect on a debt.
- Bank charges: Interest paid on business loans, ongoing credit lines, business cards, monthly maintenance, or overdraft fees.
- Maintenance: Expenses include parking fees, gas, repair and maintenance of fleet vehicles, and equipment.
- Legal expenses: These are the costs for CPAs, financial planners, or lawyers.
- Office expenses and supplies: These products include paper, notebooks, stationery, hardware, website hosting, and software.
- Tax-deductible expenses: Due to their income tax returns, companies can write off expenses that fall under the tax-deductible category. This helps lower the taxable income and liability.
- Salaries and compensation: These are the salaries for work, wages, commissions, and bonuses.
- Travel: Flights, hotels, and meals for business-related travel and expenses for candidates traveling for an interview.
Also, Read: 20 Business Expense Categories List
What is an expense account?
An expense account records and tracks the operational costs incurred by a company. Spends are recorded under an expense account, part of a company’s income statement.
Expense accounts help track costs related to different business operations and functions, like wages, rent, utilities, supplies, and other expenses. Every expense account has a unique number, which helps identify and track costs.
Its balance is closed at the end of each accounting period, and the total cost is recorded in the income statement to determine net income or loss.
What are expenses in accounting?
Expenses in accounting include everything a company spends in its way toward generating more revenue.
Some of the most specific expense categories are:
- Cost of goods sold: This includes the direct costs of goods and services production, such as raw materials, labor, and overheads.
- Administrative expenses: This category entails expenses related to day-to-day operations, like rent, utilities, salaries, marketing, or office supplies.
- Depreciation and amortization: The wear and tear of fixed assets like machinery and equipment or intangible assets such as patents or copyrights make up depreciation and amortization.
- Interest expenses: These are the interest paid on loans or other forms of debt.
- Taxes: Government taxes, like income, sales, and property taxes, are included in this expense category.
- Insurance: This category includes the insurance premiums that cover business risks such as liability, property damage, or employee benefits.
- Travel and entertainment: Business travel, client entertainment, and other business promotion costs fall under travel and entertainment.
- Professional fees: This includes lawyer fees, accountants, and payments made to other professionals for the services they get for their company.
- Research and Development: This includes the expenses of developing new products or services.
- Bad debt expenses: This includes expenses associated with unpaid customer debts that the business cannot collect.
Importance of expense accounting
Expense accounting is critical for financial management and helps companies improve performance, reduce costs, and make better strategic decisions.
It is paramount for the following reasons:
- Accurate financial reporting: Companies can generate accurate financial reports showing their economic performance. This helps with better decision-making and legal and regulatory compliance.
- Cost control: Expense accounting helps identify cost reduction and bottom-line improvement areas. Companies can tweak their operations or pricing strategies by analyzing expense trends to improve profitability.
- Budgeting and planning: Businesses can create realistic budgets and plans for the future instead of ball-parking them. This is done by tracking historical expense data and forecasting future costs.
- Tax compliance: Precise expense accounting methodologies are crucial for tax regulation compliance and preparing tax returns. With expenses, companies can calculate liabilities and claim deductions.
- Benchmarking: Comparing expense ratios of peers or competitors helps companies identify areas of cost efficiency improvement.
Related Read: Budgeting and Forecasting: A Comprehensive Guide
Understanding expense accounting
Expense accounting is a crucial aspect of a business’s financial management. It involves the identification and recording of all expenses incurred during a particular period, such as salaries, rent, utilities, supplies, and other costs related to the operations of the business. These expenses are classified according to their nature and purpose, such as direct costs or indirect costs.
The classification of expenses helps businesses to analyze their spending patterns and make informed decisions about cost-cutting measures. Expense accounting also involves the preparation of financial statements that report the company’s overall financial health, including the income statement and balance sheet.
Effective expense accounting practices help businesses to maintain accurate financial records, monitor expenses, and make sound financial decisions to achieve their goals.
Expense accounting methods
Expense accounting methods refer to the different ways in which businesses can account for their expenses. There are two primary methods for recording expenses in accounting:
- Cash basis and
- Accrual basis
1. Cash basis accounting
In cash accounting, expenses are recorded when they are paid. This means an expense is recognized only when the business pays for it.
For example, if a business pays rent for April on May 1st, it would record the rent expense in May. This method is simple and easy to understand, but it may need to accurately reflect the financial position and performance.
2. Accrual basis accounting
Under accrual accounting, expenses are recognized when incurred, regardless of when the payment is made. This means an expense is recorded when the business receives goods or services or is obligated to pay for them.
For example, if a business receives an invoice for rent in April, the rent expense would be recorded in April even if the payment is made in May. This method provides a more accurate picture of a business’s financial position and performance but requires more time and effort to track expenses.
Both methods have pros and cons.
Cash basis is more appropriate for small businesses since it is simpler and easier to manage. On the other hand, accrual is suitable for larger companies or businesses with more complex operations as it shows a more accurate picture of the financial position and performance.
Also, Read: What is Payroll Accounting?
Expense accounting procedures
Expense accounting procedures include a few steps, ranging from authorization to reconciliation:
- Authorization: In this step, a company has to set up policies and procedures that define the requesting and approving process. This helps ensure that expenditures are necessary and appropriate.
- Recording: Once an expense authorization happens, it must be recorded promptly in the company’s accounting system. This step involves assigning the expense to an account and recording spends.
- Reconciliation: Businesses must reconcile their expenses regularly to ensure they are exact and comprehensive. In this step, companies must review and verify expense reports, receipts, invoices, and other documentation.
- Approval: Next, expenses have to be approved by a designated manager or supervisor. This ensures that expenses are reasonable and comply with company policies.
- Payment: Finally, you should pay expenses promptly. This involves processing payments, tracking them, and reconciling the accounts payable.
Related Read: What are selling expenses?
How are expenses recorded in accounting?
In accounting, expenses are recorded on an accrual basis. This means that expenses are recognized when incurred, regardless of when the payment is made.
This process involves the following steps:
- Identification: The first step in recording expenses is identifying all the costs incurred during a particular period. This includes both cash and non-cash expenses.
- Categorization: You must next categorize them into different expense accounts, such as rent, salaries, utilities, and office supplies. This helps keep track of the different types of expenses incurred by the business.
- Measurement: The next step is to measure the amount of each expense. This involves recording the actual amount spent on each expense.
- Recording: The expenses are then recorded in the company’s books of accounts. The recording is done by debiting the relevant expense account and crediting either cash or accounts payable, depending on whether the expense has been paid.
- Reconciliation: Finally, the expenses are reconciled with the corresponding invoices and other supporting documents to ensure they have been recorded accurately.
Suggested Read: SG&A Selling, General and Administrative Expenses
How to implement expense accounting in your business?
Implementing expense accounting in your business is broken down into steps:
- Define your expense policy: Establish a comprehensive policy outlining what expenses are allowed and how they should be reported and approved.
- Choose expense tracking software: Select an expense tracking software that meets your business’s needs, considering cost, features, and ease of use.
- Train employees: Provide training and support to employees on the expense policy and how to use the expense tracking software effectively.
- Set up expense categories: Create a list of expense categories that align with your business’s needs, such as travel expenses, office supplies, or professional development.
- Track all expenses: Ensure that all business-related costs are tracked, regardless of size or significance.
- Regularly review and reconcile accounts: Regularly review and reconcile accounts to ensure that expenses are accurate and there are no discrepancies.
- Analyze your expenses regularly: This is done to identify areas where you can reduce costs and optimize spending.
Also, Read: What is cloud accounting?
Best practices in expense accounting
Here are some best practices for expense accounting:
- Create a clear expense policy: Establish a clear and comprehensive expense policy that outlines what expenses are allowed and how they should be reported and approved.
- Use expense tracking software: Utilize expense tracking software to automate the process of capturing receipts, tracking expenses, and generating reports.
- Set up a separate business bank account: Use a different bank account for business expenses to keep personal and business finances separate.
- Categorize expenses accurately: Ensure that payments are accurately categorized and allocated to the correct account to enable accurate financial reporting.
- Require receipts for all expenses: Ensure you have receipts so that expenses are properly documented and accounted for.
- Regularly review and reconcile accounts: Review and reconcile accounts to ensure that expenses are accurate and there are no discrepancies.
- Provide training and support: Train employees on expense policies and procedures to ensure they understand their responsibilities and can follow them effectively.
Also, Read: A Guide To Cash Accounting
Common mistakes in expense accounting
There are several common mistakes that businesses can make in expense accounting, including:
- Not keeping accurate records: Accurate record-keeping is essential for practical expense accounting. Failing to do so results in errors and inconsistencies that can considerably hurt financial performance.
- Mixing personal and business expenses: Keeping personal and business expenses separate is essential. Combining the two can lead to confusion, inaccuracies, and probable legal issues.
- Not tracking all expenses: It’s crucial to track all business-related expenses, including small ones that may seem insignificant. You must follow all costs to ensure deductible expenses and accurate financial reporting.
- Failing to follow expense policies and procedures: You should have clear policies and procedures for managing expenses. It can lead to inconsistencies, fraud, and other issues if you don’t.
- Not reconciling accounts regularly: This helps identify errors and discrepancies before they become significant problems.
Quick Read: Bookkeeping and Accounting
What ways can software help with expense accounting?
Expense accounting software helps with expense accounting in several ways, including:
- Expense tracking: The solution can automate the process of tracking expenses by allowing users to capture receipts and record expenses in real-time, reducing the risk of errors.
- Categorization and tagging: Expense accounting software automatically categorizes expenses by type, project, or other criteria, making it easier to analyze and report expenses.
- Approval workflows: It can facilitate the expense approval process by allowing managers to review and approve or reject payments in real-time, reducing the risk of fraud or non-compliance.
- Reporting and analytics: You also get detailed reports and analytics on expenses, allowing businesses to gain insights into their spending patterns and identify opportunities for cost savings.
- Integration: Many expense accounting solutions can integrate with other financial software, such as accounting or invoicing, providing a comprehensive view of a business’s financial performance.
About expense accounting software
Expense accounting software is a financial management solution designed to help businesses track and manage their expenses. It includes expense tracking, categorization, reporting, and functionalities to manage employee expenses and reimbursements.
Expense accounting software also integrates with other financial software, such as accounting or invoicing, to provide a comprehensive view of a business’s economic performance. Using it helps companies to streamline their expense management processes, reduce errors, and improve overall financial efficiency.
Best expense accounting software
Here are the top five expense accounting solutions in the market today:
- SAP Concur
Let’s take a look at each in detail:
Happay specializes in expense management solutions for companies. The platform provides a comprehensive suite of tools, including expense reporting, card payments, travel booking, and automated accounting, all designed to streamline and simplify expense processes.
Happay offers a comprehensive travel management solution with seamless integration capabilities. It also makes setting up policies easy and ensures 100% compliance during booking with automated checks.
Happay’s expense management solution has auto-capture capabilities that input expenses from the spend source, including emails, taxis, SMS, or credit card statements.
The OCR Smart Scan automatically inputs expense reports without manual intervention, and automated policy checks and violation call-outs simplify expense tracking. Users can set up approval workflows, deviations for complex business use cases, and end-to-end GST data collection, reporting, and reconciliation.
In addition, Happay provides a solution to corporate payment through the EPIC Card to record and process all employee expenses. The digital spending option allows for real-time reconciliation and transparent expense management, and digital petty cash distribution and management are also available.
Happay is utilized by various businesses, from small startups to large enterprises, and caters to multiple industries.
2. SAP Concur
SAP Concur is at the forefront of simplifying and automating everyday processes. The company’s top-rated app guides employees seamlessly through every trip while charges are effortlessly populated into expense reports and invoice approvals are automated.
SAP Concur integration of real-time data and utilization of AI ensures that all transactions are thoroughly audited, giving businesses complete transparency into their spending without any blind spots in their budget.
SAP Concur solutions enable businesses to focus on the present by making work more accessible and efficient.
Also, Read: 5 Best SAP Concur Competitors
Navan simplifies travel management with an all-in-one solution, freeing individuals to focus on their goals rather than logistical challenges. Gone are the days of tedious phone calls and manual receipt inputs. Navan empowers teams, from EAs and finance departments to travel managers and employees, to concentrate on their core objectives while delivering real-time visibility, cost savings, and governance for the business.
Navan’s seamless travel management solution eliminates the need for manual labor and streamlines travel planning and execution. With Navan, individuals can confidently embark on their journey while businesses can better control their expenses and gain insights into real-time data. Navan optimizes the travel experience for all stakeholders, enabling companies to thrive quickly.
Brex provides corporate credit cards and financial management tools specifically designed for startups, e-commerce businesses, and life sciences companies. Brex offers a variety of benefits to its customers, including higher credit limits, rewards points, and automated expense management.
Additionally, Brex does not require a personal guarantee or credit check, making it a popular choice for entrepreneurs and businesses with limited credit history.
Expensify is a web and mobile-based application that provides expense management services for businesses and individuals. The platform allows users to track and categorize expenses, create and submit expense reports, and reimburse employees.
Expensify automates many manual processes associated with expense reporting, such as data entry and receipt tracking. Expensify offers a variety of pricing plans, including a free option for individuals and small teams, as well as more advanced programs with additional features for larger organizations.
Also, Read: 10 Best Expensify Alternatives and Competitors
Expense accounting is a critical component of financial management for any business. By accurately tracking and categorizing expenses, companies can better understand their costs, make informed pricing and resource allocation decisions, and ultimately improve their profitability.
A solid understanding of expense accounting is essential for long-term success. By implementing best practices and leveraging technology solutions, businesses can optimize their expense accounting processes and gain greater visibility into their financial performance.
An expense in accounting refers to the cost incurred by a business to generate revenue. It is an outflow of economic resources, such as cash or other assets, typically recorded in the income statement account as a deduction from the cash payment.
The four types of expenses are:
a) Fixed expenses
b) Variable expenses
c) Semi-variable expenses
d) Periodic expenses
Ten examples of expenses are:
2. Salaries and wages
7. Repairs and maintenance
The three types of expenses in accounting are:
1. Operating expenses
2. Non-operating expenses
3. Capital expenses
Five examples of expense accounts are:
1. Rent expense
2. Salaries and wages expense
3. Office supplies expense
4. Advertising expense
5. Depreciation expense
Expenses are neither an asset nor a liability. They are a component of the income statement that represents a reduction in revenue and an outflow of economic resources.
An expense is a cost incurred by a business to generate revenue, while an expenditure refers to any spending, whether it generates revenue or not. In other words, all expenses are expenditures, but not all costs are.
A cost of goods sold (COGS) expense is the direct cost associated with producing or acquiring the goods sold by a company. It includes the cost of materials, labor, and overhead directly related to the production of the goods. Revenue minus expenses are the gross profit.