When you look at your company’s chart of accounts, you’ll likely notice that it’s primarily made up of expense accounts.
Given that businesses have a diverse range of expenses, from wages to utilities to office lunch shouts, it makes sense.
Naturally, many business owners and leaders wish to have a better understanding of what expense accounts are and how they work.
If that’s you, this article is here to help. We’ll explain what expense accounts are, discuss their purpose in financial accounting, provide common examples, and dive into best practices to better manage business spending.
What is an expense account?
An expense account is a record of the costs your business incurs during a given accounting period. They help you track your day-to-day expenses by organizing them into different categories, rather than having a single ledger for all expenses.
They are one of five major types of accounts used in double-entry accounting, which include:
- Asset accounts. Resources owned by the business that provide future economic benefits, like inventory or accounts receivable.
- Liability accounts. Obligations the business owes to outsiders which represent claims against its assets, such as loans or accounts payable.
- Equity accounts. The owner’s or shareholders’ claim on the company’s assets after liabilities are deducted, such as retained earnings or common stock.
- Revenue accounts. Income generated from the company’s core operations, such as sales revenue or rental income.
- Expense accounts. Costs incurred in the process of generating revenue, such as rent or advertising costs.
In double-entry accounting, debits increase expenses and credits decrease them. Expense accounts are considered temporary accounts, meaning they are zeroed out at the end of each accounting period, with the balance being closed to retained earnings. This helps draw a clear line and separate expenses between accounting periods.
You’ll find your company’s expense accounts detailed on the income statement, sometimes referred to as your profit and loss (P&L) statement.
Importance and purpose of expense accounts in financial management
The main reason for using expense accounts is to aid expense categorization.
Imagine if you didn’t have individual expense accounts, and every time your business incurred a cost, the transactions were entered into a general ledger.
Finding out how much you spent on any given expensive category, be it travel, utilities, or automotive expenses, would be a cumbersome and time-consuming nightmare.
But by using separate accounts for different categories of business spending, we can more easily run reports and issue financial statements to analyze spending habits, create accurate budgets, and make informed business decisions.
Examples of expense accounts
While the exact expense account categories a given business uses depend on both its industry and its accounting habits, these are some of the most common categories employed:
- Administrative expenses such as utilities, office supplies, and insurance.
- Employee-related expenses such as salaries, benefits, and payroll taxes.
- Marketing and advertising expenses such as digital marketing campaigns and public relations expenses.
- Cost of goods sold (COGS) such as raw materials, freight, and packaging.
- Selling expenses such as sales commissions, client meals, and trade show costs.
- Financial expenses such as bank fees, interest, and credit card processing fees.
- Travel and entertainment expenses such as hotels, business-related meals, and transportation.
- Technology expenses such as cloud services, website maintenance, and software licenses.
- Professional services such as legal fees, accounting fees, and recruitment services.
- Maintenance and repairs such as vehicle repairs, landscaping services, and equipment maintenance.
- Depreciation and amortization on assets such as vehicles, equipment, and patents.
- Miscellaneous expenses such as charitable contributions and bad debts.
- Non-operating expenses such as losses from investments, interest on debt, and extraordinary items like natural disaster costs.
- Tax expenses such as sales, income, and property taxes.
- Research and development (R&D) expenses such as testing costs, research materials, and prototype development.
How to categorize expenses correctly
Correctly categorizing business expenses is important for financial reporting, tax compliance, and spend management.
Here’s a quick overview of how to make sure you’re categorizing spending appropriately.
1. Understand expense categories
The first step is to familiarize yourself with common expense categories. You can take a look at our list above.
2. Use a chart of accounts
A chart of accounts (COA) is a list of all of the account categories tailored to your business. Create one, and group all related expenses logically, such as having all utility bills under an account called Utilities.
3. Align categories with tax requirements
Review local tax regulations and work closely with your tax advisory team to ensure that the categories you use align with reporting requirements.
4. Establish and apply consistent rules
Create guidelines for expense categorization that can be followed across all situations, such as:
“Meals go under Travel if incurred on a business trip but fall under Employee Benefits if provided in-office.”
5. Analyze and reorganize as required
Review your expense categories periodically to combine or refine categories that are redundant or unclear.
Best practices for managing expense accounts
Looking to improve how your business manages expense accounts? Integrate these best practices.
Use a dedicated business account
Keep personal and business transactions separate by using a dedicated business bank account and credit card for all transactions.
While it's possible to use personal accounts and cards, it complicates the categorization process. Maintaining a dedicated business account and card is a better move.
Establish clear expense policies
Develop guidelines for allowable expenses, spending limits, and required documentation.
For example, the employee may be able to make a purchase below a given dollar limit and submit a reimbursement claim but require prior approval for a purchase above that limit.
Track expenses in real time
Log expenses as they occur using mobile apps and automated accounting software. This will improve the accuracy of your reporting and forecasting.
Make use of integrations between the various financial software tools you use to reduce manual entry and improve data accuracy. Train employees on the importance of tracking and submitting expenses correctly.
Storage and organize receipts
Digitize receipts (either by scanning them or taking a photo) and store them securely in an accounting system or cloud storage solution.
Establish naming conventions and organization of receipts by category and date.
Perform regular reconciliations
Make it a monthly practice to match expense records with bank statements to identify and address discrepancies or errors in a timely manner.
Use accounting software
Make use of tools like Xero or QuickBooks to automate expense categorization based on preset rules.
You can even sync bank accounts for real-time updates and easier reconciliation and integrate with dedicated expense management software.
Monitor spending against budget
Set budgets for each expense category and review spending periodically. Review reports, identify areas of overspending, and implement plans to reduce expenditure or adjust budgets accordingly.
Expense accounts vs. income accounts
Expense accounts track costs incurred by a business to generate revenue and maintain operations. They record outgoing funds and reduce net income.
Income accounts (or revenue accounts) track earnings from business activities. They record incoming funds and increase net income.
Differences between expense and income accounts
Here are some of the key differences between expense accounts and income accounts:
Expense accounts for tax purposes
How are expense accounts related to tax requirements?
Tax deductions and eligible expenses
Certain business expenses can reduce taxable income, provided they meet two criteria:
- Ordinary. The expense is common and expected in the company’s industry.
- Necessary. The expense is helpful and appropriate for the business.
Some common examples of tax-deductible expenses include:
- Rent and utilities
- Office supplies
- Salaries and wages
- Interest on business loans
- Marketing and advertising
- Business travel and meals (usually with limits)
Non-deductible expenses include, but are not limited to:
- Personal expenses
- Fines or penalties
- Political contributions
- Entertainment costs (in many jurisdictions)
Record-keeping requirements for expense accounts
In order to substantiate tax details and stay compliant with tax regulations, companies must abide by some important record-keeping requirements.
These can differ by jurisdiction, but most countries require that businesses keep original receipts or invoices and proof of payment for between 3-7 years (7 years in the US). These detailed records must also include the date, amount, and business purpose of the expense.
Get on top of spending with BILL
Expenses accounts are an important aspect of double-entry accounting.
They help us categorize business expenditures to better understand spending habits across the business.
If you’re really serious about getting on top of business spending, you should consider implementing a dedicated solution like BILL , leveraging advanced features like:
- Access to business credit
- Virtual spending cards
- Deep reporting and analytics
- A dedicated mobile app
