Operating Expenses

Operating expenses are the costs of running a business’s normal operations for a period. They are reported below gross profit and taken off it to reach the operating result, which separates them from the cost of what was sold, deducted above gross profit, and from everything below the operating line: non-operating items such as interest, and income tax expense after those.

The separator is stated plainly by the SEC. Operating expenses are expenses that go toward supporting a company’s operations for a given period, and they differ from costs of sales because operating expenses cannot be linked directly to the production of the products or services being sold (SEC, Beginners’ Guide to Financial Statements). The subtotal they produce is set out in the equation for operating income, and the staircase layout that gives them a place of their own is in multi-step income statement.

What the Category Does Not Decide

Membership answers where a cost sits on the income statement, and nothing else. Whether a cost traces to a single cost object, meaning one unit, contract or client engagement it is charged to, decides direct against indirect and belongs to overhead. Whether an outlay belongs to this period at all, rather than being capitalized and recovered as an asset across later ones, is the separate question in OpEx versus CapEx and expenditure. Operating expense is also narrower than expense itself, the accounting element a period reports, defined in expense.

A Sample Set of Operating Expenses

The SEC names three members of the category outright: salaries of administrative personnel, the costs of researching new products, and marketing expenses (SEC, Beginners’ Guide to Financial Statements). Depreciation is deducted from gross profit alongside them, though depreciation on assets used in production is inventoried first and reaches income through cost of goods sold, a split covered in depreciation as an operating expense.

Rent is the standard case, because a business pays for the space it occupies whatever it happens to sell that period, and the deduction has a statutory limb of its own for rentals required as a condition to the continued use or possession of property to which the taxpayer has not taken or is not taking title or in which he has no equity (26 U.S.C. 162(a)(3)). Utilities and insurance stand beside it to the extent they serve the operation rather than the production of what is sold. A sole proprietor reports all three on named lines, rent or lease of other business property at line 20b, utilities at line 25, and insurance other than health at line 15 (IRS, Schedule C (Form 1040)).

Salaries and wages join the category to the extent the people earning them are not producing what is sold, which is why the SEC’s own example is administrative personnel. Advertising joins it because the spend moves a product that already exists rather than making it. Both are named lines on the return as well, wages at line 26 and advertising at line 8 on the sole proprietor’s schedule (IRS, Schedule C (Form 1040)), and salaries and wages at line 13 with advertising at line 22 on the corporate return (IRS, Form 1120).

Professional fees are bought by the entity rather than by any customer, so outside counsel and an outside accountant belong on the same side, at legal and professional services on line 17. Office expense at line 18 and supplies at line 22 carry what the operation consumes to keep working (IRS, Schedule C (Form 1040)). Software subscriptions have no line of their own on that form, so a preparer puts them in office expense or in the other expenses listed in Part V and totaled at line 27b.

Say a small practice’s quarter carries the operating costs below.

Rent                                18,000
Utilities                            2,400
Administrative salaries             46,000
Insurance                            3,600
Advertising                          5,000
Office expense and supplies          1,900
Legal and professional fees          2,700
Software subscriptions               7,400
Depreciation, office equipment       2,000
                                    ------
Total operating expenses            89,000

As the list is drawn, none of these is charged to a particular client file, which is what keeps every line of it below gross profit.

The Two Boundaries a Firm Codes Against

A chart of accounts built from the return’s lines cannot produce an operating subtotal without a reclassification, because the return’s expense list holds an item the statement keeps below the operating line. Part II of the sole proprietor’s schedule is titled Expenses rather than operating expenses, and it carries interest at line 16 beside advertising and rent (IRS, Schedule C (Form 1040)). The corporate return does the same, placing interest at line 18 inside the deductions block that also holds rents at line 16 and advertising at line 22 (IRS, Form 1120).

A filed income statement keeps interest out of that grouping, giving it a caption of its own below the operating cost captions along with the rest of the non-operating run (17 CFR 210.5-03), which is mapped line by line in operating income vs net income. So one interest charge is an expense on the return and a non-operating item on the statement, and a ledger that follows the form buries it inside operating cost every month.

For a practice that sells time, the other standing call is which payroll counts as delivery rather than administration, a policy the firm sets and then has to apply the same way every period, worked through in cost of revenue. Both boundaries repay an early decision, because a cost coded across either one moves a subtotal while leaving net income alone, the arithmetic in SG&A expenses.

Common Questions

Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a trial task lets a firm’s own reviewer grade real classification work before any client file moves.