Expenses are a monetary estimate of the cost of material, labor, financial, natural, informational, and other types of resources spent (planned/budgeted) on making and selling products for a certain period of time.
Accounting of expenses by type and purpose plays an important role since financial results depend on the share of expenses in the total income of the company, and one of the main tasks of management is to optimize all costs. Expenses can be classified for various purposes, such as determining the cost of manufacturing, making management decisions and planning, controlling, and regulating specific types of expenses.
Operating expenses are associated with the manufacturing and sale of products (including administrative costs), the purchase and resale of goods, as well as costs associated with the performance of work, the provision of services. Buying a coffee machine is a capital expense while operating types of expenses include the cost of purchasing the coffee itself, sugar, water, electricity, and the cost of maintaining equipment.
Operating expenses include costs aimed at:
- office supplies
- legal expenses
- telephone and internet expenses
- creation of cash reserves
- depreciation expense
- sale and write-off of goods, fixed assets, finished products
- research and development.
These are costs that a company incurs to keep the company running or in the normal course of business. Comparing these types of expenses between companies gives a fair idea of which is more efficient.
These are the costs of covering fines, penalties, losses of previous years identified in the reporting period, exchange rate differences, expenses associated with maintenance of the leased property, etc. These are also known as non-recurring items because they include one-time expenses incurred or unusual costs. They are the expenses that occur outside of the day-to-day activities of the company but are still necessary.
These expenses not related to production and sales include reasonable costs for activities that are not directly related to manufacturing or sales. So, the interest expense is the result of financing activities and would be considered as a non-operating expense (unless this company provides financial services). Non-operating expenses would also include fines and penalties for breaches of contractual and debt obligations, recognized by the company voluntarily or based on a court decision.
Major types of expenses also include fixed expenses. These costs do not depend on the volume of production. These include the costs of heating and lighting manufacturing units and offices, salaries of management personnel, depreciation of fixed assets, rent, etc.
If we use a hotel as our example, we can list at least a few fixed assets that a bookkeeper would include in the General ledger.
- Front desk employee wages
- Equipment purchase
- Furniture purchase
- Television, phone, and internet plans
- Newspaper subscriptions
- Linen and uniform purchases
- Advertising expenses
- Insurance expenses
- Mortgage payments
- Amortization of fixed assets (except amortization calculated based on units of production).
To be able to figure out if an expense is fixed or not, think if 10 or 15 more guests would mean an increase in these expenses. If the bill amount will not change, then it is a fixed expense
Some accountants prefer to single out the third type of expense – the so-called semi-fixed costs, which do not directly depend on the output but have a certain connection to it. For example, advertising costs are not directly related to how many units of a particular product a company is making, but as the product range expands, the company has to advertise more items, which affects the final price tag.
Another example of this type of cost is the cost of repairing equipment: despite the fact that fixed assets are usually repaired (maintained) according to a schedule, an increase in production creates an increased load on equipment and increases the likelihood of breakdowns.
Variable costs per unit are normalized, their amount is directly proportional to the volume of production. These include the costs of basic materials and raw materials, wages of line workers, insurance contributions, the cost of transporting goods (large volumes of products require appropriate transportation capacity), etc.
For example, in a hotel, these costs may depend on the type of services provided, as well as the number of individuals who stay at the hotel. Expenses are classified as a variable if their value depends on the volume of services provided. In our example, you might see the following items under variable expenses:
- Linen cleaning
- Fresh flower arrangements
- Free breakfast
- Cleaning supplies
- Room attendant wages and benefits
- Energy (partially).
Variable expenses, depending on the volume of services provided, can both increase (with an increase in the number of rooms being occupied) and decrease (the expenses reduce as the hotel has fewer guests). One of the interesting aspects of the behavior of variable costs is that these types of expenses are constant per unit of product, service. They are called variable because they change with the turnover of the company itself. In other words, variable costs per guest stay the same for each and every guest.