Expense

Loading the player...

What is an 'Expense'

An expense consists of the economic costs a business incurs through its operations to earn revenue. Businesses are allowed to write off tax-deductible expenses on their income tax returns to lower their taxable income and thus their tax liability. Common business expenses include payments to suppliers, employee wages, factory leases and equipment depreciation, but the Internal Revenue Service has strict rules on which expenses business are allowed to claim as a deduction.

BREAKING DOWN 'Expense'

The term "expense" also operates as a verb, and it means to write off an expense. For example, a freelance writer may expense the cost of buying writing utensils for his business, or the executive may expense the cost of taking his clients to dinner because the group discussed business at the table.

Deductible Business Expenses

According to the IRS, to be deductible, a business expense must be both ordinary and necessary. Ordinary means the expense is common or accepted in that industry, while necessary means the expense is helpful in the pursuit of earning income. Business owners are not allowed to claim their personal, nonbusiness expenses as business deductions.

Recording Expenses

Accountants record expenses through one of two accounting methods: cash basis or accrual basis. Under cash basis accounting, expenses are recorded when they are paid. For example, if a business owner schedules a carpet cleaner to clean the carpets in his office and the cleaner invoices the company for the service, a company using cash basis records the expense when it pays the invoice. Under the accrual method, however, expenses are recorded when they are incurred, and to continue with the above example, the business accountant records the carpet cleaning expense when the company receives the service.

Capital Expenses

The IRS treats capital expenses differently than most other business expenses. While most costs of doing business can be expensed or written off against business income the year they are incurred, capital expenses must be capitalized or written off incrementally.

Capital expenses are typically large expenditures considered investments into a company. They include business startup costs; business assets such as real estate, vehicles, equipment and patents; and improvements such as putting a new HVAC system into a building. Rather than writing off these expenses in the year they are incurred, business owners must write them off slowly over time. The IRS has a schedule that dictates the portion of a capital asset a business may write off each year until the entire expense is claimed. The number of years over which a business writes off a capital expense varies based on the type of asset.

RELATED TERMS
  1. Operating Expense

    A category of expenditure that a business incurs as a result ...
  2. Business Expenses

    Any expenses incurred in the ordinary course of business. Business ...
  3. IRS Publication 535 - Business ...

    A document published by the Internal Revenue Service (IRS) that ...
  4. Form 2106: Employee Business Expenses

    A tax form distributed by the Internal Revenue Service (IRS) ...
  5. Capitalize

    An accounting method used to delay the recognition of expenses ...
  6. Administrative Expenses

    The expenses that an organization incurs not directly tied to ...
Related Articles
  1. Investing

    What are Operating Expenses?

    An operating expense is any expenditure made for the purpose of operating a business. These expenses are the day-to-day costs that help keep the business going. Operating expenses are reflected ...
  2. Personal Finance

    Writing Off the Expenses of Starting Your Own Business

    Learn how to navigate the complicated rules for writing off the expenses of starting your own business. It could save you a lot of money.
  3. Markets

    Calculating Interest Expense

    Interest expense is the cost of borrowing money.
  4. Entrepreneurship & Small Business

    Business Startup Costs: It's In The Details

    Don't overlook the details when starting up a business. It's the small expenses that have the potential to make or break a great idea.
  5. Investing

    Explaining Capitalized Cost

    A capitalized cost is an expense associated with a fixed asset that is added to the basis of that asset and expensed over its depreciable life.
  6. ETFs & Mutual Funds

    Pay Attention To Your Fund’s Expense Ratio

    Even small differences in an expense ratio can have a big impact on a portfolio.
  7. Investing

    Capital Expenditure Versus Revenue Expenditure

    Capital expenditures and revenue expenses have significant differences. Here's the difference between the two.
  8. Managing Wealth

    Six Steps To A Better Business Budget

    This easy but essential process helps owners ensure that their businesses can stay afloat.
  9. ETFs & Mutual Funds

    The Lowdown on ETF Expenses

    Even small differences in an expense ratio can have a big impact.
  10. Managing Wealth

    The 4 Most Common Reasons a Small Business Fails

    Discover the most common reasons small businesses fail, including capital formation, management concerns, planning issues and marketing missteps.
RELATED FAQS
  1. What are the most common operating expenses for an online business?

    Learn about the common expenses of online businesses and find out about some of the tax implications of new business expenses ... Read Answer >>
  2. What is the difference between capital and operating expenses?

    Learn about the types of expenses that a company incurs. Understand the difference between capital and operating expenses, ... Read Answer >>
  3. What are the most common business deductions and expenses for small businesses?

    Learn about some of the most common business tax deductions available to small businesses that can reduce net business expenses. Read Answer >>
  4. Why are capital expenses (CAPEX) treated differently than current expenses?

    Learn the difference between capital expenditures, or CAPEX, and current expenses, and determine why they are treated differently ... Read Answer >>
  5. What is the difference between an operating expense and a capital expense?

    Learn the differences between an operating expense and a capital expense, and see how the two types of expenses are treated ... Read Answer >>
  6. What are the benefits of prorating expenses?

    Understand what prorating expenses means for sole proprietors and entrepreneurs. Learn about the benefits of prorating expenses ... Read Answer >>
Hot Definitions
  1. Put Option

    An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security ...
  2. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  3. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  4. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  5. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  6. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
Trading Center