Operating expenses are the expenses incurred in the entity for its normal operational purposes and activities that generally include both the cost of products or services and sales & administrative expenses. Operating expenses are generally defined when identifying and assessing the theentity’ss operating profits.
Like other income statement items, these expenses are recorded in an entity’s income statement during the period they had occurred rather than when the company paid.
Sale and administrative expenses include, but are not limited to, Sales expenses, Utility Expenses, Traveling Expenses, Telephone Expenses, Office Supplies, Legal Expenses, Banks Charges, Repair and Maintenance, Advertising Expenses, Research Expenses, Insurance Expenses, Salaries Expenses (administrative staffs) and Rental Expenses.
Cost of Goods Sold is the costs of goods or products sold during a specific period by the entity. The costs here refer to direct costs that are directly attributable to the goods or products sold, including direct labor, direct materials, and direct overheads.
The cost needs to be matched with the entity’s revenues recognized in the income statement.
Definition of Expenses as per IFRS:
The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity. Expenses that arise in the course of the ordinary activities of the entity include, for example, the cost of sales, wages, and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant, and equipment.
Losses represent other items that meet the definition of expenses and may, or may not, arise in the course of the ordinary activities of the entity. Losses represent decreases in economic benefits and as such, they are no different in nature from other expenses. Hence, they are not regarded as a separate element in the Conceptual Framework.
Losses include, for example, those resulting from disasters such as fire and flood, as well as those arising on the disposal of non-current assets. The definition of expenses also includes unrealized losses, for example, those arising from the effects of increases in the rate of exchange for foreign currency in respect of the borrowings of an entity in that currency. When losses are recognized in the income statement, they are usually displayed separately because knowledge of them is useful for the purpose of making economic decisions. Losses are often reported net of related income.
There is no definition of the exact term “Operating Expense” in both IFRS and US GAAP. Only”“Expense”” does. Some publishers define operating expenses as covering only Sales and Administrative Expenses.
Yet, we know that we calculate the operating expenses because we want to know and assess the entity operating income. And operating income is calculated by eliminating both costs of goods sold and sales and administrative expenses.
List and Example of Operating Expenses:
The following are the example of Sales and General Administrative Expenses and Cost of Goods sold:
General Administrative Expenses:
- Utility Expenses: These are the expenses related to water and electricity expenses that use for daily operating activities.
- Traveling Expenses: These are the expenses that the company pay for its staff traveling to meet customers, suppliers, and other related activities. These expenses are for the company’s purpose only. For personnel traveling expenses, it is depending on the company’s decision. Some company allows certain of management to claim or provide personnel traveling allowance.
- Telephone Expenses: These are the telephone cost that incurs at the office which normally builds on a monthly basis. For example, line phone or desk phone. Also the same as traveling expenses, the company has policies to provide an allowance for its management team a certain amount of telephone expenses. Expenses are sometimes bear fringe benefit.
- Office Supply and Equipment type of expenses for purchasing the office suppliers for use in the office every day. For example, papers, pens, clippers, and others.
- Legal Expenses: These are the expenses that occur as the result of the company use legal services.
- Bank Charges: It can be the fee charged by banks for transactions processing, for Check Fee or other related Cost.
- Repair and Maintenance: The repair and maintenance expenses that occur for repairing services for the requirements, machines, or vehicles in the company.
- Advertising Expenses: Promotion and advertising, but these expenses are not including the trade discount that the company provides to its customers.
- Research Expenses: These are the expenses that occur for researching new products. This cost could not be capitalized.
- Insurance Expenses: The insurance expenses are including health care insurance, general insurance for staff and, fire insurance for an office building.
- Entertainment Expenses incurred for sales and other operational support.
- Sales expenses like sales discount and sales commission expenses.
Cost of Goods Sold:
The cost of goods sold is usually calculated by:
Cost of Goods Sold for the period: Opening Inventories + Purchase – Closing Inventories
And the cost that is normally included in the cost of goods sold is:
- Freight in and freight out costs
- Direct materials and direct labor costs
- Rental cost for production-related support
- Salaries, wages, and benefits for production staffs
- Depreciation expenses and repair & maintenance for productions fixed assets
Others costs that contributed directly to productions.
Here is no specific formula to calculate operating expenses, but as long as you understand how to calculate operating income that reports in the income statement, you can calculate operating expenses.
Normally, operating expenses are recorded in the income statements to determine the operating income after taking them out from gross profits.
Here is how it look like;
Sales Revenues $XXXX
Less Cost of Goods Sold ($XXXX)
Equal Gross Profit $XXXX
Less Sales and General
Administrative Expenses ($XXXX)
Equal Operating income $XXXX
Operating Expenses VS Non-Operating Expenses:
Operating expenses are different from capital expenditure because operating expenses are the group of expenses that occur for operational purposes only. These expenses occur and are recorded as expenses in the income statement for the year.
Capital Expenditures or CAPEX is the type of expense that occurs as the result of purchasing long-term assets.
These expenses are not recorded in the income statements for the year incurred. Instead, they are recorded as fixed assets and depreciate based on accounting policies.
It is operating and capital expenditures are not the official terms used to prepare financial reporting. It is the economic accounting term used by management for operational purposes only.
This is why you could not find the definition of these two terms in IFRS or US GAAP.
Operating Expenses Analysis:
- Review the trend of gross profit ratio by comparing the ratio from period to period to see the unusual trend. The cause may be because of the cost of goods sold or sales discounts. And see if there is any room to improve.
- Review the trend of operating profit ratio. The ratio could give you the idea if the operating expenses are occurred consistently align with its operating activities as well as the trend of sales. This ratio just gives you the signal if there any line of expenses goes wrong. You still need to review line by line and then assess whether you could improve it or not.
- Compare the key operating expenses with the budget so that you can see if there any expenses that jump unreasonably above the budget. If there is, then you need to deep down to see what really happened. For example, reviewing the salary expenses recording in the income statement with the budget that approves by the board of directors. Review the market expenses incurred against the budget. Those expenses may jump over the budget and the reason might be because the plan is not accurate or efficient problems.
- Compare the key operating expenses with the previous year is also important to help track the reasonableness of current year recordings. For example, depreciation expenses are likely to appear consistently with previous year records if there is no significant disposal or addition.
Recording operating expenses are the same as recording other costs in the income statement. The expenses are recorded in debit in the income statement when they occur or increase. The contra entry of those expenses could be decreased assets or increased liabilities depending on the nature of business transactions. For example, if the operating expenses here are the depreciation expenses, then the records should be
Dr operating expenses in the income statement as depreciation expenses and ten Cr the accumulated depreciation in the balance sheet.
Another example, if the operating expenses are the utility expenses, then the records here should be:
Dr utility expenses in the income statement in the period those expenses occurred, and then credit liabilities of the entity are not making the payment at the month/yearend or credit bank/cash if the payment is made in the balance sheet.