Yesterday was all about income, cost of goods sold, and why it’s important to keep income and expenses in the same period.
Today, we’re looking at what makes an expense and a few common examples.
Expenses are the resources required to generate income and will decrease an asset account or increase a liability account (we’ll talk about these in later lessons). They’re what you spend money on to allow the business to continue running from day to day.
Expenses need to be categorized consistently because if they’re not always put into the same expense accounts, the income statement becomes nearly useless.
If we spend money on something big, like a new printer or a new car, this does not qualify as an expense. It needs to be capitalized and put on the balance sheet as an asset (we’ll talk about assets in a later lesson).
This goes back to the matching principle we talked about yesterday. A large purchase will be used over many years, which means we need to spread out the purchase over many years. Capital assets is part of a later lesson, so I won’t say any more about it here, but it’s important to know why a capital asset can’t be expensed.
Similar to capital assets, prepaid expenses aren’t expensed all at once either. A prepaid expense is exactly what it sounds like, an expense that was prepaid. These are usually things like insurance or membership dues that are paid annually up front.
If you expensed it all in the month you paid for it and then had no insurance costs for the rest of the year, it wouldn’t be a true representation of the resources required to generate income.
As I said in earlier lessons, you should categorize your expenses in a way that makes sense to you. Sometimes it’s nice to have a guide, though, so here are common expense accounts and what most businesses use them for.
Interest and bank charges: I would categorize everything related to bank charges here. That includes service fees, Interac e-transfer fees, and visa interest. If you pay a lot in interest or have a large loan (like a mortgage), it might be worth it to separate interest into its own account.
Bad debt expense: Use this account when you have a client who doesn’t pay you. When you write off an invoice, it decreases Accounts Receivable and increases this account.
Meals and entertainment expense: This is for meals or client outings. Remember that you can’t expense things like golf course memberships, personal meals, or vacations.
Office supplies expense: This is anything office related, like pens, paper, printer ink, etc.
Legal and professional fees: This is if you need to pay an accountant or a lawyer. Sometimes, other things can go in here too, but usually, it’s only accounting and lawyer fees.
Professional development expenses: This is for education expenses related to the business. For example, as an accountant, I need to take a certain number of continuing education hours. If I need to pay for the courses, I would put the cost here.
Transaction fees: These are credit card processing fees, like Stripe and PayPal.
Rent expense: If you rent an office or retail space, the rent payments would go in here.
Online software expenses: If you have a bunch of apps you pay for, you could group them all in here. If you only have a few and they don’t cost very much, you could group them in another account, like office expenses.
Expenses need to be categorized consistently, and now that you know the most common expense accounts, you can be more confident with your expense mapping and management.
Task: Keep a listing of your accounts and what you use them for so you can remember what to do when you get a new transaction in your business. Having this list and the expense mapping done will also allow you to hand off your bookkeeping to someone else pretty easily.
Tomorrow is all about reconciling bank statements. Now that you know how to categorize your income and expenses, we need to make sure what you’ve recorded matches the bank statement.
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