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If It Cost That Much It Must Be an Expense!
In the world of the small business owner there are costs and expenses right? You probably think you have your sales, cost of sales and then those nasty expenses you have to pay. While you’d be somewhat right, that’s not the only difference between costs and expenses.
When considering what is the difference between cost and expense, let’s look at a small business scenario:
John owns a candle shop that sells import candles. He knows the holiday season is near so John orders $500 worth of candles to cover the holiday season. He may not sell the entire inventory, but he doesn’t want to run out either, so he places $100 worth of candle inventory in his warehouse—this becomes an asset.
Once the holiday season is over, John has sold $400 of inventory which is his expense, the remaining $100 becomes an asset, and $500 was his cost.
In the world of financial accounting and journal entries, your debits and credits must equal, hence:
- Cash out – Credit of $500 (this is his cost)
- Sales – Debit of $400 (this is his expense)
- Inventory - $Debit of $100 (this becomes an asset in inventory)
If you’re still confused, here are more examples of the difference between cost and expense.
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This Land Is Your Land, But That’s My Vehicle!
Certain assets can be a cost but not necessarily an expense. For example, if the small business owner buys land and a building, the land will always remain a cost because basically they aren’t making any more land these days so it only appreciates in value. For the building, however, what the business owner paid for the building can be depreciated and becomes an expense as well as an asset. Building repairs can also be an expense.
The same holds true for a company vehicle. While it’s an asset that can depreciate, the initial paid price is the cost and the depreciation is the expense. As the vehicle depreciates, so does the value of the asset.
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If You Build It, They Will Come
If you own an auto service shop and sell brake jobs, then you’ll really be confused now (or at least I was until I understood the accounting principles behind these equations). Not only do we have sales, but we have cost of sales, and cost of inventory. So where’s the expense? What about labor? If you have to pay someone to perform those brake jobs, that’s your expense and what you pay for those brakes to keep in inventory is your cost.
Why must this all be so confusing you may ask? As stated earlier, general ledgers are bound by the debits and credits contained within them, and are made via journal entries. If your debits and credits don’t match, you’ll be out of balance every accounting period and that means your accountant will be digging through your books searching for that missing journal entry.
A simple way to remember the difference between expenses and costs are what did it cost you to buy something and how much did you have to pay out to sell it (the expense
You can learn more on general accounting principles here on Bright Hub and even find out where to take an online accounting course!
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- Accounting Scholar - http://www.accountingscholar.com/what-is-difference-between-cost-expense.html
- Rhonda Chase, CPA – Taos, New Mexico – Telephonic Interview 10/19/10
- Cost Vs Expense Can Be Confusing (Freedigitalphotos)
- 2011 Chevy Volt - courtesy Ford Media Room (Jean Scheid is a registered user of the Ford Media Room)
- Is That a Cost or an Expense (Freedigitalphotos)