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Businesses run on expenditures, and spendings keeps your business running. But what are business expenses, and how many business expenses are there? Let’s Understand the concept of business expenses, their definition, and types. Get expert insights on deductible business expenses, documentation, and compliance requirements.
Business expenses are the costs that you spend to run your business. The total business expenses are subtracted from the business's total revenue to reach the business's net income. A proper record of expenses can help the business to make financial decisions. Most of the business expenses are deductible under the income tax act; the deduction of expenses reduces the tax liability.
Business expenses are classified into two main categories: capital and revenue expenses.
Capital Expenditures:
Capital expense (capex) refers to the money an organization spends to maintain, buy, or improve its fixed assets, such as land, buildings, plant & machinery and equipments. Capex is recorded as an investment in the balance sheet rather than as an expense on the income statement. Capex can include costs related to acquiring or creating a fixed asset, such as fees, transportation, installation, and registration. For example, if a company buys a building and pays a commission to the broker, the purchase price and the commission are considered capex. Capex can also include costs related to extending or improving a fixed asset or replacing a significant part of an existing fixed asset. The benefit of such spending is expected to last for more than one year.
Examples of Capital Expenses: Some of the examples of capital expenditure includes the following:
Revenue Expenses:
Revenue expenditure is a company's regular cost to support its business operations and earn revenue in a specific period. It does not create any long-term benefit or asset for the company. It is related to the fixed assets that the company uses for production or sales. For example, maintenance, repair, rent, wages, etc., are revenue expenditures. They are recorded in the company's income statement for the period they are incurred.
Examples of Revenue Expenses:
As per the Income Tax Act, businesses must maintain books of accounts and other documents that enable the Assessing Officer to calculate their taxable income. The books of accounts should include a cash book, journal, ledger, bills, and receipts issued and received by the business. The books of accounts should be maintained if the income or turnover of the business exceeds certain limits specified in Section 44AA and Rule 6F of the Income Tax Act. For example, for businesses and professions having gross receipts of more than ₹ 1 crore and 50 Lakhs respectively in a financial year, a tax audit is mandatory, and the books of accounts should be maintained. ITR should be filed electronically by 30th September of the assessment year. Likewise, for businesses having cash transactions of more than Rs 10,000 for any expense, such expense will not be allowed as a deduction under section 40A(3) of the Income Tax Act. Therefore, businesses should be careful about documenting their expenses and complying with the requirements of the Income Tax Act to avoid any penalties or disallowances.
Some examples of direct expenses are direct labor, direct materials, manufacturing supplies, freight inwards, and customs duty. These costs can be directly linked to purchasing or producing goods or services.
Some examples of indirect expenses are rent, utilities, office expenses, depreciation, and administrative salaries. These costs are not clearly related to the core product or service but are necessary for the overall functioning of the business.
A salary can be either a direct or an indirect expense, depending on the employment contract. For example, a salary paid to a factory worker is a direct expense, as it can be directly linked to the cost of production. However, a salary paid to an associate in the office is an indirect expense, as it cannot be directly linked to specific goods.
Depreciation expense is an indirect expense that represents the diminution in the value of a fixed asset over the time due to wear and tear, obsolescence, or impairment. Depreciation expense reduces the asset's book value and is stated as an expense on the income statement.
Fixed expenses are the costs that do not vary with the level of Sales or output, such as rent, insurance, salaries, etc.
Variable expenses are the costs that change with the output or sales, such as raw materials, utilities, commissions, etc.
