Small business owners know that managing expenses is critical. But how do you decide when to record the different types of expenses that your small business incurs? Let’s familiarize ourselves with the expense recognition principle, so that you can better understand how expense reporting software like ours can benefit your small business. What is Expense Recognition? Every expense that your small business incurs requires the use of an asset from the other side of your balance sheet. If this sounds intimidating, don’t worry – you can brush up on those concepts and their role in the accounting equation here. Back to it, then. You’ll need to record any expenses that your small business incurs in your ledger. To this end, we recommend using small business accounting software that generates expense receipts – not only for your own reference, but also in the event that you eventually need to report your financial performance to outside parties! You’ll record your expenses on the income statement, either at the time the expense occurs, or at a later point in time. If we’re talking about a longer-term asset, such as a piece of equipment or property that has been used up and converted into an expense, you’ll need to move this asset from your balance sheet to your income statement. this requires moving the asset from the balance sheet to the income statement. Conversely, if you’re dealing with a short-term asset like office supplies, you can record your expenses directly on the income statement. If any of this sounds overwhelming, take a look at our piece on primary financial statements here. Following the Matching Principle Now, let’s talk about when an expense gets recognized. First principles dictate that you will recognize expenses in your financial statements whenever you record revenues that are associated with those expenses. This is in line with the matching principle, one of the key components of the Generally Accepted Accounting Principles (GAAP). In a nutshell, you’re making sure your expenses “match up” with any related revenues that your small business has generated. Let’s take a look at how this would play out in real life. Say your small business sells custom clothing, and you’ve spent $5,000 in October on raw materials required to make your product. You then sell that clothing in November, bringing in $7,500 in revenues. As per the expense recognition principle, you should wait to record the $5,000 expense until the associated revenue is received in November! Be sure to keep a close record of all your expense receipts via automated small business accounting software to eliminate headaches! Product Costs vs Period Costs The decision to recognize an expense right away, or in the future, depends on which of the two basic types of costs your small business is dealing with: product costs, or period costs. Product costs are any costs that relate directly to a product, and raw materials and labour will likely be the most frequent costs your small business faces. As we saw above, accounting principles allow you to wait to record product cost expenses until your small business has received the revenues associated with those expenses. Compare this to period costs, where you will recognize expenses as they are incurred. A common example of this are salaries and administrative costs. You’ll need to log these costs as they are incurred in your small business accounting software to ensure your expense recognition is up-to-date! You’ll never regret having a handle on your company’s expense recognition policies – luckily, our expense recognition software makes this process seamless! Questions? Get in touch with us at answers@kashoo.com!
