Definition of Expense
Expense
The reduction in value of an asset as it is used for current company operations.
Related Terms:
For investment companies, the management fee and "other expenses,"
including the expenses for maintaining shareholder records, providing shareholders with financial statements,
and providing custodial and accounting services. For 12b-1 funds, selling and marketing costs are included.
The percentage of the assets that were spent to run a mutual fund (as of the last annual
statement). This includes expenses such as management and advisory fees, overhead costs and 12b-1
(distribution and advertising ) fees. The expense ratio does not include brokerage costs for trading the
portfolio, although these are reported as a percentage of assets to the SEC by the funds in a Statement of
Additional Information (SAI). the SAI is available to shareholders on request. Neither the expense ratio or the
SAI includes the transaction costs of spreads, normally incurred in unlisted securities and foreign stocks.
These two costs can add significantly to the reported expenses of a fund. The expense ratio is often termed an
Operating expense Ratio (OER).
Charged to an expense account, fully reducing reported profit of that year, as is appropriate for
expenditures for items with useful lives under one year.
What was spent to run the non-sales and non-manufacturing part of a company, such as office salaries and interest paid on loans.
The total amount that was spent to run a company this year.
What was spent to run the sales part of a company, such as sales salaries, travel, meals, and lodging for salespeople, and advertising.
Those that vary with the amount of goods you produce or sell. These may include utility bills, labor, etc.
The costs incurred in buying, making or producing goods and services.
expenses that have to be recorded in order for the financial statements to be accurate. Accrued expenses usually do not involve the receipt of an invoice from the company providing the goods or services.
An expense account that represents the portion of the cost of an asset that is being charged to expense during the current period.
Costs involved in running the company.
The amount of expense incurred for the general operation of an office.
The amount paid to employees for services rendered; synonymous with salary expense and wage expense.
The amount of tax associated with salaries that an employer pays to governments (federal, state, and local).
expenses that have been paid for but have not yet been used up; examples are prepaid insurance and prepaid rent.
Rent expense
The amount of expense paid for the use of property.
Salary expense
The amount paid to employees for services rendered; synonymous with payroll expense and wage expense.
Wage expense
The amount paid to employees for services rendered; synonymous with salary expense and payroll expense.
accrued expenses payable
The account that records the short-term, noninterest-
bearing liabilities of a business that accumulate over time, such
as vacation pay owed to employees. This liability is different than
accounts payable, which is the liability account for bills that have been
received by a business from purchases on credit.
fixed expenses (costs)
expenses or costs that remain the same in amount,
or fixed, over the short run and do not vary with changes in sales volume
or sales revenue or other measures of business activity. Over the
longer run, however, these costs increase or decrease as the business
grows or declines. Fixed operating costs provide capacity to carry on
operations and make sales. Fixed manufacturing overhead costs provide
production capacity. Fixed expenses are a key pivot point for the analysis
of profit behavior, especially for determining the breakeven point and for
analyzing strategies to improve profit performance.
revenue-driven expenses
Operating expenses that vary in proportion to
changes in total sales revenue (total dollars of sales). Examples are sales
commissions based on sales revenue, credit card discount expenses, and
rents and franchise fees based on sales revenue. These expenses are one
of the key variables in a profit model. Segregating these expenses from
other types of expenses that behave differently is essential for management
decision-making analysis. (These expenses are not disclosed separately
in externally reported income statements.)
unit-driven expenses
expenses that vary in close proportion to changes
in total sales volume (total quantities of sales). Examples of these types of
expenses are delivery costs, packaging costs, and other costs that depend
mainly on the number of products sold or the number of customers
served. These expenses are one of the key factors in a profit model for
decision-making analysis. Segregating these expenses from other types
of expenses that behave differently is essential for management decisionmaking
analysis. The cost-of-goods-sold expense depends on sales volume
and is a unit-driven expense. But product cost (i.e., the cost of
goods sold) is such a dominant expense that it is treated separately from
other unit-driven operating expenses.
variable expenses
expenses that change with changes in either sales volume
or sales revenue, in contrast to fixed expenses that remain the same
over the short run and do not fluctuate in response to changes in sales
volume or sales revenue. See also revenue-driven expenses and unitdriven
expenses.
Operating expense
Any expense associated with the general, sales, and administrative
functions of a business.
Prepaid expense
An expenditure that is paid for in one accounting period, but which
will not be entirely consumed until a future period. Consequently, it is carried on the
balance sheet as an asset until it is consumed.
Current Income Tax Expense
That portion of the total income tax provision that is based on
taxable income.
Deferred Income Tax Expense
That portion of the total income tax provision that is the result
of current-period originations and reversals of temporary differences.
Income Tax Expense
See income tax provision.
Fixed Expenses
Cost of doing business which does not change with the volume of business. Examples might be rent for business premises, insurance payments, heat and light.
management expense ratio (MER)
The total expenses expressed as an annualized percentage of daily average net assets. MER does not include brokerage fees and commissions, which are also payable by the Fund.
Operating Expenses
The amount of money the company must spend on overhead, distribution, taxes, underwriting the risk and servicing the policy. It is a factor in calculating premium rates.
Asymmetry
A lack of equivalence between two things, such as the unequal tax treatment of interest expense
and dividend payments.
Basis
Regarding a futures contract, the difference between the cash price and the futures price observed in the
market. Also, it is the price an investor pays for a security plus any out-of-pocket expenses. It is used to
determine capital gains or losses for tax purposes when the stock is sold.
Beggar-thy-neighbor
An international trade policy of competitive devaluations and increased protective
barriers where one country seeks to gain at the expense of its trading partners.
Beggar-thy-neighbor devaluation
A devaluation that is designed to cheapen a nation's currency and thereby
increase its exports at other countries' expense and reduce imports. Such devaluations often lead to trade wars.
Business risk
The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.
Capitalized interest
Interest that is not immediately expensed, but rather is considered as an asset and is then
amortized through the income statement over time.
Cash flow from operations
A firm's net cash inflow resulting directly from its regular operations
(disregarding extraordinary items such as the sale of fixed assets or transaction costs associated with issuing
securities), calculated as the sum of net income plus non-cash expenses that were deducted in calculating net
income.
Debt-service coverage ratio
Earnings before interest and income taxes plus one-third rental charges, divided
by interest expense plus one-third rental charges plus the quantity of principal repayments divided by one
minus the tax rate.
Deferred taxes
A non-cash expense that provides a source of free cash flow. Amount allocated during the
period to cover tax liabilities that have not yet been paid.
Depreciation
A non-cash expense that provides a source of free cash flow. Amount allocated during the
period to amortize the cost of acquiring Long term assets over the useful life of the assets.
Earnings before interest and taxes (EBIT)
A financial measure defined as revenues less cost of goods sold
and selling, general, and administrative expenses. In other words, operating and non-operating profit before
the deduction of interest and income taxes.
Financial control
The management of a firm's costs and expenses in order to control them in relation to
budgeted amounts.
Free rider
A follower who avoids the cost and expense of finding the best course of action and by simply
mimicking the behavior of a leader who made these investments.
Horizontal analysis
The process of dividing each expense item of a given year by the same expense item in
the base year. This allows for the exploration of changes in the relative importance of expense items over time
and the behavior of expense items as sales change.
Income statement (statement of operations)
A statement showing the revenues, expenses, and income (the
difference between revenues and expenses) of a corporation over some period of time.
Interest coverage ratio
The ratio of the earnings before interest and taxes to the annual interest expense. This
ratio measures a firm's ability to pay interest.
Net income
The company's total earnings, reflecting revenues adjusted for costs of doing business,
depreciation, interest, taxes and other expenses.
Net lease
A lease arrangement under which the lessee is responsible for all property taxes, maintenance
expenses, insurance, and other costs associated with keeping the asset in good working condition.
Net profit margin
Net income divided by sales; the amount of each sales dollar left over after all expenses
have been paid.
Other current assets
Value of non-cash assets, including prepaid expenses and accounts receivable, due
within 1 year.
Perquisites
Personal benefits, including direct benefits, such as the use of a firm car or expense account for
personal business, and indirect benefits, such as up-to-date office décor.
12B-1 fees
The percent of a mutual fund's assets used to defray marketing and distribution expenses. The
amount of the fee is stated in the fund's prospectus. The SEC has recently proposed that 12B-1 fees in excess
of 0.25% be classed as a load. A true " no load" fund has neither a sales charge nor 12b-1 fee.
Vertical analysis
The process of dividing each expense item in the income statement of a given year by net
sales to identify expense items that rise faster or slower than a change in sales.
Zero-sum game
A type of game wherein one player can gain only at the expense of another player.
ACCRUAL
A method of accounting in which you record expenses when you incur them and sales as you make them—not when you pay bills or receive checks in the mail.
GROSS PROFIT
The profit a company makes before expenses and taxes are taken away.
INCOME STATEMENT
An accounting statement that summarizes information about a company in the following format:
Net Sales
– Cost of goods sold
--------------------
Gross profit
– Operating expenses
--------------------
Earnings before income tax
– Income tax
--------------------
= Net income or (Net loss)
Formally called a “consolidated earnings statement,” it covers a period of time such as a quarter or a year.
NET INCOME
The profit a company makes after cost of goods sold, expenses, and taxes are subtracted from net sales.
PROFIT
What’s left over after you subtract the cost of goods sold and all your expenses from sales.
Accrual
An expense for profit purposes even though no payment has been made.
Accruals accounting
A method of accounting in which profit is calculated as the difference between income when it is earned and expenses when they are incurred.
Capitalize
To make a payment that might otherwise be an expense (in the Profit and Loss account) an asset
(in the Balance Sheet).
Cash accounting
A method of accounting in which profit is calculated as the difference between income
when it is received and expenses when they are paid.
Controllable profit
The profit made by a division after deducting only those expenses that can be controlled by the
divisional manager and ignoring those expenses that are outside the divisional manager’s control.
Depreciation
An expense that spreads the cost of an asset over its useful life.
Line item
Generic types of assets, liabilities, income or expense that are common to all businesses and
used as the basis of financial reporting, e.g. rent, salaries, advertising etc.
Non-production overhead
A general term referring to period costs, such as selling, administration and financial expenses.
Operating profit
The profit made by the business for an accounting period, equal to gross profit less selling, finance, administration etc. expenses, but before deducting interest or taxation.
Overhead
Any cost other than a direct cost – may refer to an indirect production cost and/or to a non-production expense.
Prepayment
A payment made in advance of when it is treated as an expense for profit purposes.
Profit
The difference between income and expenses.
Profit and Loss account
A financial statement measuring the profit or loss of a business – income less expenses – for an accounting period.
Accumulated depreciation
A contra-fixed asset account representing the portion of the cost of a fixed asset that has been previously charged to expense. Each fixed asset account will have its own associated accumulated depreciation account.
Assets
Items owned by the company or expenses that have been paid for but have not been used up.
Closing entries
The entries that transfer the balances in the revenue, expense, and dividend accounts to Retained earnings and zero out the revenue, expense, and dividend accounts for the next period.
Income Statement
One of the basic financial statements; it lists the revenue and expense accounts of the company.
The Income Statement is prepared for a given period of time.
Indirect method
A method of preparing the operating section of the Statement of Cash Flows that does not use the company’s actual cash inflows and cash outflows, but instead arrives at the net cash flow by taking net income and adjusting it for noncash expenses and the changes from last year in the current assets and current liabilities.
Petty cash
The amount of currency and coin that a company keeps on hand to pay for small purchases and expenses.
accelerated depreciation
(1) The estimated useful life of the fixed asset being depreciated is
shorter than a realistic forecast of its probable actual service life;
(2) more of the total cost of the fixed asset is allocated to the first
half of its useful life than to the second half (i.e., there is a
front-end loading of depreciation expense).
accrual-basis accounting
Well, frankly, accrual is not a good descriptive
term. Perhaps the best way to begin is to mention that accrual-basis
accounting is much more than cash-basis accounting. Recording only the
cash receipts and cash disbursement of a business would be grossly
inadequate. A business has many assets other than cash, as well as
many liabilities, that must be recorded. Measuring profit for a period as
the difference between cash inflows from sales and cash outflows for
expenses would be wrong, and in fact is not allowed for most businesses
by the income tax law. For management, income tax, and financial
reporting purposes, a business needs a comprehensive record-keeping
system—one that recognizes, records, and reports all the assets and liabilities
of a business. This all-inclusive scope of financial record keeping
is referred to as accrual-basis accounting. Accrual-basis accounting
records sales revenue when sales are made (though cash is received
before or after the sales) and records expenses when costs are incurred
(though cash is paid before or after expenses are recorded). Established
financial reporting standards require that profit for a period
must be recorded using accrual-basis accounting methods. Also, these
authoritative standards require that in reporting its financial condition a
business must use accrual-basis accounting.
accumulated depreciation
A contra, or offset, account that is coupled
with the property, plant, and equipment asset account in which the original
costs of the long-term operating assets of a business are recorded.
The accumulated depreciation contra account accumulates the amount of
depreciation expense that is recorded period by period. So the balance in
this account is the cumulative amount of depreciation that has been
recorded since the assets were acquired. The balance in the accumulated
depreciation account is deducted from the original cost of the assets
recorded in the property, plant, and equipment asset account. The
remainder, called the book value of the assets, is the amount included on
the asset side of a business.
amortization
This term has two quite different meanings. First, it may
refer to the allocation to expense each period of the total cost of an
intangible asset (such as the cost of a patent purchased from the inventor)
over its useful economic life. In this sense amortization is equivalent
to depreciation, which allocates the cost of a tangible long-term operating
asset (such as a machine) over its useful economic life. Second, amortization
may refer to the gradual paydown of the principal amount of a debt.
Principal refers to the amount borrowed that has to be paid back to the
lender as opposed to interest that has to be paid for use of the principal.
Each period, a business may pay interest and also make a payment on
the principal of the loan, which reduces the principal amount of the loan,
of course. In this situation the loan is amortized, or gradually paid down.
bad debts
Refers to accounts receivable from credit sales to customers
that a business will not be able to collect (or not collect in full). In hindsight,
the business shouldn’t have extended credit to these particular
customers. Since these amounts owed to the business will not be collected,
they are written off. The accounts receivable asset account is
decreased by the estimated amount of uncollectible receivables, and the
bad debts expense account is increased this amount. These write-offs
can be done by the direct write-off method, which means that no
expense is recorded until specific accounts receivable are identified as
uncollectible. Or the allowance method can be used, which is based on
an estimated percent of bad debts from credit sales during the period.
Under this method, a contra asset account is created (called allowance
for bad debts) and the balance of this account is deducted from the
accounts receivable asset account.
big bath
A street-smart term that refers to the practice by many businesses
of recording very large lump-sum write-offs of certain assets or
recording large amounts for pending liabilities triggered by business
restructurings, massive employee layoffs, disposals of major segments of
the business, and other major traumas in the life of a business. Businesses
have been known to use these occasions to record every conceivable
asset write-off and/or liability write-up that they can think of in
order to clear the decks for the future. In this way a business avoids
recording expenses in the future, and its profits in the coming years will
be higher. The term is derisive, but investors generally seem very forgiving
regarding the abuses of this accounting device. But you never
know—investors may cast a more wary eye on this practice in the future.
breakeven point
The annual sales volume level at which total contribution
margin equals total annual fixed expenses. The breakeven point is only a
point of reference, not the goal of a business, of course. It is computed by
dividing total fixed expenses by unit margin. The breakeven point is
quite useful in analyzing profit behavior and operating leverage. Also, it
gives manager a good point of reference for setting sales goals and
understanding the consequences of incurring fixed costs for a period.
capitalization of costs
When a cost is recorded originally as an increase
to an asset account, it is said to be capitalized. This means that the outlay
is treated as a capital expenditure, which becomes part of the total
cost basis of the asset. The alternative is to record the cost as an expense
immediately in the period the cost is incurred. Capitalized costs refer
mainly to costs that are recorded in the long-term operating assets of a
business, such as buildings, machines, equipment, tools, and so on.
cash burn rate
A relatively recent term that refers to how fast a business
is using up its available cash, especially when its cash flow from operating
activities is negative instead of positive. This term most often refers
to a business struggling through its start-up or early phases that has not
yet generated enough cash inflow from sales to cover its cash outflow for
expenses (and perhaps never will).
cash flow
An obvious but at the same time elusive term that refers to cash
inflows and outflows during a period. But the specific sources and uses
of cash flows are not clear in this general term. The statement of cash
flows, which is one of the three primary financial statements of a business,
classifies cash flows into three types: those from operating activities
(sales and expenses, or profit-making operations), those from
investing activities, and those from financing activities. Sometimes the
term cash flow is used as shorthand for cash flow from profit (i.e., cash
flow from operating activities).
cash flow from operating activities, or cash flow from profit
This equals the cash inflow from sales during the period minus the cash
outflow for expenses during the period. Keep in mind that to measure
net income, generally accepted accounting principles require the use of
accrual-basis accounting. Starting with the amount of accrual-basis net
income, adjustments are made for changes in accounts receivable,
inventories, prepaid expenses, and operating liabilities—and depreciation
expense is added back (as well as any other noncash outlay
expense)—to arrive at cash flow from profit, which is formally labeled
cash flow from operating activities in the externally reported statement
of cash flows.
contribution margin
An intermediate measure of profit equal to sales revenue
minus cost-of-goods-sold expense and minus variable operating
expenses—but before fixed operating expenses are deducted. Profit at
this point contributes toward covering fixed operating expenses and
toward interest and income tax expenses. The breakeven point is the
sales volume at which contribution margin just equals total fixed
expenses.
current assets
Current refers to cash and those assets that will be turned
into cash in the short run. Five types of assets are classified as current:
cash, short-term marketable investments, accounts receivable, inventories,
and prepaid expenses—and they are generally listed in this order in
the balance sheet.
current liabilities
Current means that these liabilities require payment in
the near term. Generally, these include accounts payable, accrued
expenses payable, income tax payable, short-term notes payable, and
the portion of long-term debt that will come due during the coming year.
Keep in mind that a business may roll over its debt; the old, maturing
debt may be replaced in part or in whole by new borrowing.
depreciation
Refers to the generally accepted accounting principle of allocating
the cost of a long-term operating asset over the estimated useful
life of the asset. Each year of use is allocated a part of the original cost of
the asset. Generally speaking, either the accelerated method or the
straight-line method of depreciation is used. (There are other methods,
but they are relatively rare.) Useful life estimates are heavily influenced
by the schedules allowed in the federal income tax law. Depreciation is
not a cash outlay in the period in which the expense is recorded—just
the opposite. The cash inflow from sales revenue during the period
includes an amount to reimburse the business for the use of its fixed
assets. In this respect, depreciation is a source of cash. So depreciation is
added back to net income in the statement of cash flows to arrive at cash
flow from operating activities.
earnings before interest and income tax (EBIT)
A measure of profit that
equals sales revenue for the period minus cost-of-goods-sold expense
and all operating expenses—but before deducting interest and income
tax expenses. It is a measure of the operating profit of a business before
considering the cost of its debt capital and income tax.
extraordinary gains and losses
No pun intended, but these types of gains
and losses are extraordinarily important to understand. These are nonrecurring,
onetime, unusual, nonoperating gains or losses that are
recorded by a business during the period. The amount of each of these
gains or losses, net of the income tax effect, is reported separately in the
income statement. Net income is reported before and after these gains
and losses. These gains and losses should not be recorded very often, but
in fact many businesses record them every other year or so, causing
much consternation to investors. In addition to evaluating the regular
stream of sales and expenses that produce operating profit, investors
also have to factor into their profit performance analysis the perturbations
of these irregular gains and losses reported by a business.
gross margin, or gross profit
This first-line measure of profit
equals sales revenue less cost of goods sold. This is profit before operating
expenses and interest and income tax expenses are deducted. Financial
reporting standards require that gross margin be reported in
external income statements. Gross margin is a key variable in management
profit reports for decision making and control. Gross margin
doesn’t apply to service businesses that don’t sell products.
income statement
Financial statement that summarizes sales revenue
and expenses for a period and reports one or more profit lines for the
period. It’s one of the three primary financial statements of a business.
The bottom-line profit figure is labeled net income or net earnings by
most businesses. Externally reported income statements disclose less
information than do internal management profit reports—but both are
based on the same profit accounting principles and methods. Keep in
mind that profit is not known until accountants complete the recording
of sales revenue and expenses for the period (as well as determining any
extraordinary gains and losses that should be recorded in the period).
Profit measurement depends on the reliability of a business’s accounting
system and the choices of accounting methods by the business. Caution:
A business may engage in certain manipulations of its accounting methods,
and managers may intervene in the normal course of operations for
the purpose of improving the amount of profit recorded in the period,
which is called earnings management, income smoothing, cooking the
books, and other pejorative terms.
inventory turnover ratio
The cost-of-goods-sold expense for a given
period (usually one year) divided by the cost of inventories. The ratio
depends on how long products are held in stock on average before they
are sold. Managers should closely monitor this ratio.
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