An expense is the using up of assets, or the incurring of liabilities, that a period reports because the business delivered or produced goods, rendered services, or carried out other activities. It is the cost a period consumed, which on accrual books is a different event from the money leaving the bank.
The FASB’s conceptual framework treats it as a defined element rather than a category of spending. Expenses are outflows or other using up of assets of an entity or incurrences of its liabilities, or a combination of both, from delivering or producing goods, rendering services, or carrying out other activities (FASB Statement of Financial Accounting Concepts No. 8, Chapter 4, paragraph E81). A general dictionary carries the working business sense in its legal definition, an item of business outlay chargeable against revenue for a specific period, and its verb sense runs the same line, to charge to an expense account or to write off as an expense (Merriam-Webster).
Other activities is not filler in that definition. It means the activities that let others use the entity’s resources, which for example result in interest, rent, royalties and fees (the same statement, paragraph E84).
What an Expense Is Not
A Cost the Business Has Not Used Up Yet
A cost becomes an expense only as it is consumed. An asset is a present right of an entity to an economic benefit (the same statement, paragraph E16), and while the business still holds that right, the cost has not been used up. A case of paper bought in December and still on the shelf at the year end is an asset then, and an expense in the month someone opens it.
An Expenditure
The outlay and the recognized cost are two different events, and a capitalized outlay is not an expense yet at all. That split, and the rules that decide which outlays get capitalized instead, are set out in expenditure.
A Loss
A loss is a decrease in equity that is not an expense, because the framework defines losses by excluding the decreases that result from expenses or distributions to owners (the same statement, paragraph E83), so one item is never both. All four elements of a period are set out together in income statement.
The framework’s own illustration is one machine sold two ways. The proceeds from the sale of a machine displayed as inventory would be considered revenue, and the cost of that machine would be considered an expense, while the proceeds from the sale of a machine used by an entity in a productive capacity would not be considered revenue and the entity would report a gain or a loss upon disposition (the same statement, paragraph E86). Nothing about the machine changed. What it was doing for the business did.
What the Word Means on a Return
On a return the word means the deduction, and the Code allows that deduction in the same word. There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business (26 U.S.C. 162(a)).
The regulation under it does not keep the accounting split at all. Business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer’s trade or business, except items which are used as the basis for a deduction or a credit under provisions of law other than section 162 (26 CFR 1.162-1(a)). An amount can be an expenditure in the accounting sense and an expense in the statutory one at the same time.
Two limits sit on it. One is what the spending was for: except as otherwise expressly provided in that chapter, no deduction shall be allowed for personal, living, or family expenses (26 U.S.C. 262(a)).
The other is which year it lands in, and that turns on the taxpayer’s method of accounting. Under the cash receipts and disbursements method, amounts representing allowable deductions shall, as a general rule, be taken into account for the taxable year in which paid (26 CFR 1.461-1(a)(1)). For an accrual method taxpayer the all events test is not treated as met any earlier than economic performance (26 U.S.C. 461(h)(1)), so a cost that is right on the December ledger can still be a next-year deduction. The all events test and economic performance are both worked through in accrual accounting.
Until the cash catches up, the amount leaves a balance behind: a liability where the cost was incurred first, set out in accruals, and an asset where the payment ran ahead of the benefit, set out in deferral.
Common Questions
In the plural the word names the individual items a period reports rather than the element behind them, so a firm’s expenses for a month are its wages, its rent, its utilities and the rest. None of them belongs to that month unless the assets were used up in it, or the liability incurred in it.
Expense. That is the spelling the dictionary entry carries (Merriam-Webster), and the one the Code uses in the heading of the section that allows the deduction, Trade or business expenses (26 U.S.C. 162).
The regulation on business expenses gives a working list, and among the items it names are labor, supplies, incidental repairs, advertising and other selling expenses, insurance premiums against fire, storm, theft, accident or other similar losses in the case of a business, and rental for the use of business property (26 CFR 1.162-1(a)). What puts each of them on that list is the same test, that the amount is ordinary and necessary and connected with the trade or business, rather than the form the spending took.
No authority fixes a list of four. The framework defines one element and not four kinds of it (the same statement, paragraph E81), and the splits people count, operating against non-operating or fixed against variable, are classifications laid over that one element for presentation or for management.
Of those, the operating and non-operating split is the one a US filing rule writes into its captions, putting selling, general and administrative expenses at caption 4 above the non-operating captions that follow it (17 CFR 210.5-03). Where each caption falls on the way to the bottom line is in net income.
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