Expenditure vs. Expense: Are the Terms Synonymous?
Explaining Expenditure in Context
Sections below further define, explain, and illustrate expenditure. Note especially that the term appears in context with similar terms and related, including:
Businesspeople use quite a few different terms related to payments and spending obligations. Many, however, confuse spending-related terms or use them interchangebly when in fact they are not truly synonyms and are not interchangeable. Some, for instance, see the terms expensive and costly as meaning the same thing. And, many make little distinction between the terms expense, expenditure, and cost.
These terms all have different meanings, however. While there may be no harm in confusing these terms in everyday conversation, those engaged in business planning, budgeting, and financial accounting need to understand precisely the meaning of each.
Exhibit 1 below shows that the broadest or most inclusive of these terms is cost. All of the terms in light blue and yellow cells are, arguably, costs.
Cost and Costing in Accounting
To accountants, cost primarily means an amount of money that rims give up or pay out to acquire something, usually goods or services. The name of an accounting activity, cost accounting, is an example of this usage.
In cost accounting, accountants use the term cost object to refer to any item associated with a cost figure of its own. The term applies to a very wide range of items, which accountants "cost" by estimation, by direct measurement, or by allocation or apportionment. Cost object items may include, for instance:
- Services (such as consulting services with a specified cost).
- Goods (such as raw materials for producing products).
- Products (for example, a product whose costs of design, development, and production are specified).
- Projects (for example, a product design project).
- Customers (customers when the cost of selling or service delivery is known).
- Contracts (such as, a product warranty support contract, when the costs of contract creation and service delivery are known).
- Resources (for example, fuel for operating vehicles).
- Activities (such as use of a vehicle to deliver goods).
Defining Cost Broadly
However, businesspeople also use the term cost widely—and appropriately—when referring to other kinds of losses or negative impacts, including non-financial negative impacts. Management may say, for example, that a recently declared pay freeze has "cost the company dearly in terms of lower employee morale." Or, marketers may say that the company is paying a heavy cost, or a heavy price, in terms of lower brand image due to poor product quality.
In other words, when defined broadly, the term cost can include expenditures of all kinds as well as non-financial negative impacts.
Exhibit 1 below recognizes both the broader meaning of cost as well as the accountant's narrower definition.
What is the Meaning of Sunk Cost?
A sunk cost is a cost that has already been incurred and is not recoverable. It is usually not relevant to a decision concerning present or future alternatives. Two well-known phrases capture the sense in which financial professionals generally view sunk costs:
- "It's water under the bridge"
- "Don’t throw good money after bad."
Some businesspeople are tempted to consider sunk costs when making decisions about future actions. To them, it seems at first that disregarding sunk costs is irresponsibly abandoning funds already invested. In any case, such an attachment is undeniably more emotional than rational.
However, the cold rational view is that sunk costs should have no relevance for the decision or choice under consideration. This is because sunk costs are now "history," and will not change no matter which decision option prevails for the future. For this reason, sunk costs do not belong in forward-looking business case analysis, when the analysis provides decision support for a recommending a future course of action.
An expenditure is spending activity the firm pays with cash or cash equivalents. Expenditures serve at least four different purposes:
- Firstly, to acquire an asset.
- Secondly, to distribute funds to owners (e.g., through drawing accounts).
- Thirdly, to reduce a liability (e.g., payoff a loan)
- Fourthly, as an expense.
Expense: A decrease in owner’s equity due to using up assets.
Two Kinds of Expense Categories
Expenses belong to two kinds of expense categories: .
Firstly, expenses are either operating expenses or non-operating expenses.
- Employee wages and salaries, for instance, are operating expenses, because the support operations in the firm's normal line of business.
- Non-operating expenses.penses can include regular interest payments due on debt, or one-time expenses such a restucturing charge.
Secondly, expenses are either cash expenses or non-cash expenses
- Inventory purchase expense, for example, is a cash expense.
- The best known example of a non-cash expense, for instance is depreciation expense.
Every expenditure in business is a financial event. And, expenditures—like all other financial events—must register in one way or another in the firm's accounting system.
Most business firms practice double entry accrual accounting, even though this approach more complex and more difficult to use than the simpler alternative, single entry accounting. Public companies and other firms use double entry accounting because they cannot otherwise meet government and regulatory requirements for reporting and record-keeping. With a single entry system alone, moreover, firms cannot accurately track their own assets, liabilities, equities, revenues, and expenses.
As a result, every expenditure and every other financial event:
- Impacts at least two accounting system accounts.
- Calls for at least one debit transaction and one credit transaction. Total debits for the event must equal (offset) total credits for the event.
When entering expenditure-related transaction into the system, bookkeepers and accountants are responsible for knowing (a) which accounts to impact, and (b) which accounts to credit and which to debit.
When a firm pays cash to acquire assets, the financial event is an expenditure but not an expense. The reason that asset acquisitions do not initially register as expenses has to do with several core principles of accrual accounting:
- Firms report (claim) expenses only when actually incurring them.
- Firms incur expenses for assets only as they actually use up, wear out, or exhaust them.
- For depreciable assets, the time period over which firms incur expenses by using up assets is the asset's depreciable life. A similar decrease in value occurs over time for amortizable assets through an amortizable life.
- The value of inventory assets is used up across whatever time period is required to convert the inventory into cash or Accounts Receivable.
- Other kinds of assets, such as prepaid expenses, wasting assets, or intangible assets also have "lives" specified by accounting rules, over which they lose book value as they incur expenses.
In brief, an expense by definition decreases the value of the asset bases by paying funds out of the firm. By contrast, a cash expenditure for asset purchase simply transfers one pool of asset value (cash) into another asset category (such as Merchandise Inventory, or Factory Machines).
The asset expenditure brings expenses over time, however, as expenses charged for depreciation, amortization, or usage. These asset-caused expenses do reduce the asset base, and do reduce earnings (profits).
Profit = Revenues – Expenses
Expense item expenditures can appear under any of the five major Income statement headings.
- Expense Item for Cost of goods sold COGS.
Cost of goods sold (COGS, CGS, or cost of services, or cost of sales) is the total cost of acquiring raw materials and turning them into finished goods or delivered services.
- Operating Expenses for Selling.
Selling expenses include salaries and commissions for sales people.
- Operating Expenses - General & Administrative (G&A).
Operating expenses cover operating the firm's normal line of business. G&A expenses may therefore include such things as: executive salaries, administrative employee wages, research and development, travel, training, and IT support, and depreciation.
- Financial Expenses.
Financial expenses include payments associated with borrowing or earning income from financial investements ( Note that this category exists only for firms that are not in financial industries).
- Extraordinary Items.
These are costs for large one-time events or transactions, outside the firm's normal line of business. y determines which budget includes this item.
Charging expenses in any of these categories—including both cash and non-cash expenses—lowers "bottom-line" profits.
Firms sometimes disburse funds directly to company owners (shareholders). These payments are expenditures, not expenses.
For instance, when a public company closes its books after a profitable accounting period, its Board of Directors designates how the firm will distribute this income. The Board formally announces this distribution through the Statement of Retained Earnings. This report shows how Income Statement profits from the period either transfer to the Balance sheet, as retained earnings, or through expenditures to shareholders as dividends.
Dividend payments are not expenses as long as the firm pays them from "Surplus Undivided Funds accounts," or "Drawing Accounts." Funds in these accounts are from the period's profits which have not yet entered the equity base, are not carried as assets. By contrast, any payments actually taken from Retained earnings would draw down the equity base and therefore qualify as expenses.
Owner disbursements, in other words, do not contribute to the bottom line profit calculation.
In many cases, firms repay debt with a combination of expenditures and expenses.
Taking on debt brings an obligation to repay, of course, but taking on debt also incurs expenses. The largest and best known debt-related expenses are interest obligations, which debtors normally pay periodically to a lender or to bond holders.
The only important exceptions to the practice of periodic interest payments are so-called zero-coupon bonds, such as US Government Savings Bonds. For these bonds, the issuer completely pays both interest and principle with a single lump-sum payment at maturity.
In any case, repayment of the borrowed principle itself represents an expenditure. Payments for interest and other borrowing-related costs (such as loan-origination fees) are expense payments. As a result, when a firm makes a periodic bank loan payment, accountants recognize two components in the payment total: (1) An expenditure that contributes towards paying off the loan principal, and (2) an expense component covering interest due.
Firm's often anticipate the loan repayment expenditure using a kind of special purpose savings account, a sinking fund. Sinking funds normally reside in interest-paying bank accounts, which means payments into the account earn interest on themselves thereby helping to build the fund.
Sinking funds are cash assets but on the Balance sheet they list under "Long Term Assets" and not "Current Assets." This is because their funds are not available for any other purpose until they ultimately pay off the debt, When it is time to pay off the debt, the sinking fund balance transfers to a normal (Current Assets) cash account, and from their transfers as an expenditure to retire the debt.