Which term refers to an expense that is the same amount every time you pay it?

Definition: When transactions are recorded in the books of accounts as they occur even if the payment for that particular product or service has not been received or made, it is known as accrual based accounting. This method is more appropriate in assessing the health of the organisation in financial terms.

Description: To understand accrual accounting, let's first understand what we mean when we say the word 'accrual'. Accrual refers to an entry made in the books of accounts related to the recording of revenue or expense paid without any exchange of cash.

The use of accrual accounting is typically useful in businesses where there are a lot of credit transactions or the goods and services are sold on credit, which simply means that there was no exchange of cash.

Let's understand Accrual accounting with the help of an example. Suppose you are a firm M/S ABC Pvt Ltd, and you are using accrual accounting to maintain your books of accounts. Here, any revenue or income which is generated by sales and expenses incurred are recorded as they occur.

If you sell your goods or products on credit, the sale is recorded in the books based on the invoice generated. There is a possibility that you may not have received the payment by cash at that particular point in time.

An expense is occurred or recorded when the raw material is ordered and not when the actual payment is made to the supplier by either cash or cheque. The only drawback of this type of accounting system is that you, as a firm, might end up paying tax on revenues even when you might have not received it (credit).

Under the accrual method of accounting expenses are balanced with revenues on the income statement. It helps give a better picture of the company's financial condition.

Costs and expenses are similar concepts, and they're sometimes used interchangeably, but there are some differences for businesses to consider. A cost typically refers to the price paid to acquire an asset, while an expense is an ongoing expense, such as an employee's salary or rent on a retail space.

What's the Difference Between Costs and Expenses?

CostsExpensesRegularityImplies one-time purchaseOngoing payments like rent, utilities, etc.AccountingUsed to calculate assetsUsed to calculate profitsTaxesDon't directly affect taxesCan be tax-deductible

Regularity

Cost is the amount that is paid to buy or obtain something. Cost implies a one-time event, like a purchase. The term "cost" is often used in business in the context of marketing and pricing strategies.

The term "expense" implies something more formal and something related to the business balance sheet and taxes. An expense is an ongoing payment, like utilities, rent, payroll, and marketing. For example, the expense of rent is needed to have a location to sell retail products from.

Accounting

Accountants use cost to refer specifically to business assets, and even more specifically to assets that are depreciated (called depreciable assets). The cost (sometimes called cost basis) of an asset includes every cost to buy, deliver, and set up the asset, and to train employees in its use.

Note

There is usually no asset (something of value) associated with an expense. Buying a building is a cost; the cost is the one-time price you pay. Paying interest every month on your mortgage for that building is an expense.

The cost of assets shows up on the business accounting on the balance sheet. The original cost will always be shown, then accumulated depreciation will be subtracted, with the result as book value of that asset. All the business assets are combined for the purpose of the balance sheet.

Taxes

Expenses are used to produce revenue (seek profit) and they are deductible on your business tax return, reducing the business's income tax bill. To be deductible, they must be "ordinary and necessary" to the business.

Costs don't directly affect taxes, but the cost of an asset is used to determine the depreciation expense for each year, which is a deductible business expense. Depreciation is considered a "non-cash expense" because no one writes a check for depreciation, but the business can use it to reduce income for tax purposes.

Which Is Right For You?

Here are some situations in which it may make more sense to refer to "costs" rather than "expenses" (or vice versa).

When You Should Use Costs

Costs typically refer to the price paid to a producer or seller for a product you need. These costs can be fixed (consistent) or variable (fluctuating based on your sales volume, market conditions, or something else).

Note

The term cost of goods sold refers to the calculation done at the end of an accounting year for businesses that sell products. The cost of goods sold measures all costs associated with sales.

Costs can be direct or indirect. Indirect costs include labor, storage costs, and the pay for factory or warehouse supervisors. Direct costs include:

• Products bought for resale
• Raw materials to make products
• Packaging and shipping products to customers
• Inventory of finished products
• Direct overhead costs for utilities and rent for a warehouse or factory
  

For example, if a manufacturing business buys a machine, the cost includes shipping the machine, setting it up, and training employees to use it. Cost basis is used to establish the basis for depreciation and other tax factors.

When You Should Use Expenses

Expenses show up on your business profit and loss statement.

Note

Keeping track of fixed and variable expenses can be helpful in determining the breakeven point for product pricing. More important, it's a budgeting tool to minimize fixed costs when times get tough.

You can also consider an expense as money you spend to generate revenue. For example, consider these expenses:

• You need to spend money on advertising to get customers.
• You need to spend money on a phone number so customers can call you.
• You need to spend money on rent and utilities if you want to have a retail store for customers to visit.
• You need to spend money on a web page to attract online customers.
  

Key Takeaways

• Costs are related to buying business assets, and they're shown on the business balance sheet.
• The cost of an asset is usually depreciated (spread over time).
• Expenses are related to business expenditures over time, and they are shown on the business net income (profit and loss) statement.
• Most ordinary and necessary business expenses are tax-deductible.

Frequently Asked Questions (FAQs)

What is opportunity cost?

Opportunity cost refers to the missed opportunity to pursue another option. This might not be a direct cost that you pay upfront. For example, the opportunity cost of working instead of going to school is that you miss out on an education. The opportunity cost of quitting your job so you can go to school is the loss of income from working.

What is the expense ratio in a mutual fund?

An expense ratio is a common way of letting investors know how much it costs to invest in a certain product (mutual fund, ETF, etc.). The ongoing expense is expressed as a ratio of the total investment. For example, if you have $1,000 invested in a mutual fund with an expense ratio of 0.05%, then you will pay $50 per year in fees.

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