One of my senior asked me "Mangesh is expense & expenditure is same? What will be the treatment of expense or expenditure in accounting?". I quickly said it's same & it is shown in Profit & Loss Account. He laughed & told me google it. To my surprise it came out two different things & it treatment in accounting is also different.
Here I will explain why it is necessary to understand the meaning of both terms in simple words- no boring definition, will learn with examples.
Many of us use the word expense & expenditure interchangeably. But in accounting they have separate meaning. They affect the bottom line i.e. Profit.
1. Expense-- Outflow of money--money is spent-- leading to expense
2. Expenditure-- Outflow of money-- money is spent-- leading to expense & assets.
Mr. A started a business & made below transactions.
1. Purchase Machines- 3,00,000.00
2. Purchase Raw Material- 1,00,000.00
3. Paid Fixed Expense- 50,000.00
4. Sold Products- 2,50,000.00
Now we have to determine whether Mr. A had made profit or Loss. From this example we will also understand the term - Profit.
We can say that Mr. A had done sales of 2.5 lacs & made expenses of 4.5 lacs it's seem that Mr. A had made loss.. If you thought Mr, A has made loss you probably had calculated Profit minus Expenditure instead of Profit minus Expense.
But it's not the proper way of calculating a profit. The money which we receive & which we spent need to be separated.
Money Received= Income or Liability &
Money Spent= Expense or Asset
From the above explanation we can determine our profit.
Remember- Item should be appear as an expense only if it satisfies the test of consumption.
To understand the consumption, there are few question that we have to asked to create a better understanding about what appears on the expense's side & what appears on the income side.
Taking the above question as an example we can concluded that if
1. Whether the raw material purchase of Rs. 1,00,000.00 was used in order to earn 2,50,000.00 income?
2. Did the entire raw material got consumed in the process of earning Rs. 2,50,000.00?
3. If the company want to earn another 2,50,000.00 will it have to spend another 1,00,000.00 on raw materials?
If the answer is yes to the above questions we can list the raw material as expense.
If not, we must ask how much was spent to earn to Rs. 2,50,000.00. Suppose only 70,000.00 was consumed to earn 2.5 lacs, then 30,000.00 will appear in the Balance sheet as Inventory.
Now the Profit will change-
The same questions is applicable for all the other items in financial statement. Let's say in case of Fixed Expense if a certain portion was paid as advance, than that component will appear on the Asset's side.
Let's say in case of Machinery. Was machinery worth of 3,00,000.00 was fully used to generate sales of 2,50,000.00 ? -- If we wish to earn another 2,50,000.00 we will have to buy another machine? If the answer is yes then the machine cannot be called an asset.
Let assume that machine worth 3,00,000.00 did not consumed at once & infact it is going to help Mr. A to earn similar amounts years after years. Let say for 10 years. This means that if not the entire 3,00,000.00 at least 1/10th of the amount should be shown as an expense.
Therefore we have to reduce the assets value by 30,000.00 & this amount need to shown as an expense in profit & loss Account. This terminology is called as Depreciation.
Now checkout the proper Financial Statement:-
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