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

    An operating expense is an expenditure that a business incurs ...
  2. Administrative Expenses

    The expenses that an organization incurs not directly tied to ...
  3. General And Administrative Expense ...

    General and administrative expenses (G&A) are the group of expenditures ...
  4. Accounting Method

    Accounting method refers to the rules a company follows in reporting ...
  5. Form 2106: Employee Business Expenses

    An IRS tax form to deduct expenses incurred while conducting ...
  6. Transaction

    1. An agreement between a buyer and a seller to exchange goods, ...
Related Articles
  1. Small Business

    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.
  2. Small Business

    Capital Expenditure Versus Revenue Expenditure

    Capital expenditures and revenue expenses have significant differences. Here's the difference between the two.
  3. Small Business

    6 steps to a better business budget

    Learn how budgeting helps owners understand how to keep their businesses running. These six tips can help you create a top-notch small business budget.
  4. Taxes

    Tax Tips For Financial Advisors

    Self-employed advisors have a number of unique expenses, but the tax benefits often compensate for the financial burdens.
  5. Small Business

    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.
  6. Tech

    Top Tax Tips to Deduct Investment Management Fees

    Investment expenses can be deducted by those who meet three main criteria. Here's what they are and how they work.
  7. Small Business

    Small Business: Speed Up Receivables To Avoid A Cash Crunch

    Waiting for customers to pay can be a losing game. Look to factoring for quicker cash.
  8. Small Business

    Financial Planning Tips for Small Business Owners

    These practical steps can help business owners establish a successful financial plan.
  9. Investing

    Understanding profit metrics: Gross, operating and net profits

    Rather than relying solely on a company's net profit figures, seasoned investors will often look at gross profit and operating profit as well.
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. If I pay for a course to learn about trading can I write some of it off?

    There are some investing costs that can be written off each year, even if you aren't a day trader. The general rule in determining ... Read Answer >>
  3. How operating expenses and cost of goods sold differ?

    Operating expenses and cost of goods sold are both expenditures used in running a business but are broken out differently ... Read Answer >>
  4. What is the difference between recurring and non-recurring general and administrative ...

    Understand the expenses involved in a company's general and administrative operating costs and the difference between recurring ... Read Answer >>
  5. When are businesses required to use accrual accounting?

    Determine when the accrual accounting method must be used instead of cash accounting. Most businesses use accrual accounting ... Read Answer >>
Hot Definitions
  1. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  2. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  3. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  4. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  5. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  6. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
Trading Center