Costs and expenses

Costs represents the nominal amount of the company's assets spent on achieving specified utility effect; usually given in monetary terms. It can be simply measured by summing up all outgoes for supplies, labor, products, services, equipment or any other item bought for the business use. Costs are all denoted resources for the invoices associated with the company's main activity that are recorded in the bookkeeping records.

Expense is an outflow of the money in cash or non-cash (bank account) form or other asset, possessing the feature of liquidating liabilities of the accounting entity toward the others. The outflow of cash is usually one side of a trade for services or products that have equal or higher utility value for the buyer then for the seller. Expense occurs in the cash circuit, hence its directly associated with conducting financial processes.

Cost and expenses classifications

Classification is the process of identifying costs and expenses according to their common features. Various ways of classifying serves a different purpose and the interpretation of the information that is conveyed may vary depending on the department in which is analyzed:

Direct and indirect costs are sorted into direct or indirect on the basis of their possibility of being assigned with cost units.

Direct costs are those easily identifiable with a product. If output units are the objects of costing, then direct costs and assets that can be sorted to the finished product. An examples of direct costs can be cost of raw materials, wages for production employees (direct labor).

Indirect costs are those which cannot be traced to a single product because they are incurred for more than one product. Giving the examples: managerial salaries (indirect labor), power, lighting, insurance. Indirect costs, usually referred as overhead have to be divided to different products.

Fixed and variable costs Considering costs with the changing size of the production we can distinguish: Fixed costs: the amount of assets used does not change when size of the production differs from the basic level.

Variable costs the amount change simultaneously with changing size of the production. Variable costs may include: salaries of the workers employed in production, energy cost, raw materials used. In fixed costs can be shown amortization, administration expenses, renting costs. Sum of fixed and variable costs gives total costs, which divided by the quantity of the products made, informs us about the unitary cost.

Operating and financial expenses

Usually classified with the company's activity fields:

1. Operating expense

• operating expense from basic activity
• other operating expenses

1. Financial expenses
2. Investment expenses (additional)

Operating expenses from basic activities are those associated with main business interest in production, commercial and service fields.

Other operating expenses are those linked with sale and liquidate of fixed assets as well as intangible assets; paid fees, costs related to social activities and transferred donations

Financial expenses i.e. the value of securities sold at the purchase price, commissions on loans and credits, interests charged against delayed liability payments.

Investment expenses are incurred wholly or partially in connection with the investing of funds and the obtaining of investment income.

Relation between costs and expenses

Costs and expenses are two terms that can be misinterpreted. Cost is expressed as a nominal consumption of fixed and current assets, services, investments of work and certain expenditure that are not the consumption (taxes, social security) associated with the operation of normal activities by the enterprise in a specific period of time. An expense is a cost that has expired or was necessary in order to earn revenues.

Price is frequently linked to the cost of a product to the producer or seller. Expenses show up on your business profit and loss statement. In a business sense, an expense is "an item of business outlay chargeable against revenue for a specific period." "Chargeable against revenue" means that expenses are figured against gross income in the calculation of profits and losses .

The correct description between costs and expenses has the significant meaning for the legitimate preparation of the financial statement - cash flow and profit & loss account. In the business activity conducted by a given unit, the expense and cost may occur at the same time, e.g. fuel purchase - at the moment of buying it's just an expense but while exploiting it becomes a cost. Sometimes there may happen a cost without an expense, like using resources that we have gotten without payment required. Another example could be a bank loan: paying off interests (expense) is simultaneously the cost of the financial activity. There can also occur a time discrepancy between the cost and the expense e.g. truck amortization (cost) and the amount paid for the truck (expense) at the beginning.

Referenceis

• Wermers, R. (2000). Mutual fund performance: An empirical decomposition into stockpicking talent, style, transactions costs, and expenses. The Journal of Finance, 55(4), 1655-1695.
• Arora, M.N., (2014) Cost Accouting. Theory, Promlems and Solutions. Himalaya Publishing House, 1.9-1.18
• Murray, J. (2018) Cost vs. Expense - What is the Difference?

Footnotes

Author: Natalia Windys

Costs and expenses — recommended articles

Total income — Cost structure — Sundry income — Gross revenue — Long-Term Assets — Income from operations — Depreciation vs. amortization — Cost — Non-operating expense