Costs vs Expenses: What Are the Differences?
By Indeed Editorial Team
Updated November 7, 2022
Published September 25, 2020
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Many people use “costs” and “expenses” interchangeably, but it's important when operating a business or handling the organization's accounting to be able to tell the two apart. Learning the differences between costs and expenses will help ensure proper management of your company's finances.
In this article, we distinguish between costs and expenses, including how each is used in business accounting, and we provide examples to guide you.
What is a cost?
A cost is an amount paid to acquire an asset. It typically refers to a one-time payment for the purchase of a fixed asset or an asset procured for long-term use not quickly converted into cash like land, buildings and equipment.
A cost can also refer to prepaid expenses, such as prepaid insurance. For example, a company's insurance bill when applied over the course of six months remains a cost until it has been used up or expired at the end of its term. If the insurance policy is paid monthly, the monthly rate is considered an expense and the prepaid insurance treated as an asset will continue to decrease accordingly by the monthly rate paid.
Types of costs
There are two primary types of costs called “fixed” and “variable.” A fixed cost does not change over the short term, even if changes take place within the business. Instead, it is often connected to a fixed period of time, such as a rental lease or employee salary. Fixed costs are deducted from a business' monthly gross income to yield a monthly net income or revenue. A high fixed-cost level thereby requires a higher revenue level to avoid business losses at year-end.
Some examples of fixed costs include:
Certain intangible assets (i.e. patents)
Tangible assets (i.e. equipment, vehicles)
Fixed interest rates incorporated into loan agreements
Salaries, or fixed compensation amounts paid to employees
Utilities (i.e. electricity, phones)
A variable cost is one that varies with changes to the business. Because these costs rely on fluctuations in business activity, they are much less apparent in the short-term. Businesses often start with more fixed costs than variable costs. The predictability that comes from this set-up can also help guarantee or increase a business' profitability early on by attaching a fixed revenue goal to the bottom line. Over the long-term, though, most costs will inevitably become variable rather than fixed.
Examples of variable costs include:
What is an expense?
While a cost is generally a one-time payment, an expense is best described as an amount paid regularly towards ongoing business operations. These payments are important to a company's ability to generate revenues. Expenses directly impact profitability ratios or the amount by which revenues or profits exceed the costs and expenses associated with doing business. Expenses are thereby helpful in determining and evaluating a company's overall performance.
However, these payments do not have a lasting benefit for the business. In other words, expenses are consistently “used up” or expire.
Types of expenses
Depending on the type and size of the business there can be many or little expenses. Expenses are thereby contingent on many factors related to business operations just as business operations are dependent on expenses.
Common expenses might include:
Cost of goods sold for ordinary business operations
Wages, salaries, commissions, other labor (i.e. per-piece contracts)
Repairs and maintenance
Utilities (i.e. heat, A/C, lighting, water, telephone)
Losses on sales of non-current assets
Expenses can be further broken down into two separate categories called “operating” and “non-operating” expenses. Although, all expenses are paid towards the operations of the business.
Operating expenses might include:
Cost of goods sold
Marketing, advertising, promotions
Wages, salaries, employee benefits
Depreciation of assets
Within operating expenses, you can have expenses related to compensation, office administration and operation, and sales and marketing. Examples of each are shown below:
Compensation: Wages, salaries, other compensation, payroll tax, commissions (can also be factored into part of the costs of goods sold), benefits, pension plan
Office administration: Accounting expenditures, depreciation of fixed assets, insurance costs, legal fees, office supplies, property taxes, rent, repairs and maintenance, utilities
Sales and marketing: Advertising, direct mailing, entertainment and meals, sales materials (i.e. brochures), travel
Read more: What Are Operating Expenses? (With Examples)
Non-operating expenses might include:
Impairment charges or a drastic reduction in the recoverable value of a fixed asset
Costs and expenses in accounting
For accounting purposes, costs are reflected on the balance sheet. Accumulated depreciation is deducted from the original cost of each asset thereby yielding the “book value” of the asset. The total cost or cost basis of an asset can include the purchase price, shipping, set-up and training related to the acquirement and use of the asset. The sum of all business assets is then tallied to be included on the balance sheet.
For businesses that sell products, the costs of goods sold including costs to make, ship and store the goods will also be totaled at year-end. Expenses are conversely reflected on the profit-or-loss statement that reflects the company's net income or profits/revenues. The expenses are taken off the top of the monthly gross income thereby reducing the business' overall revenue.
Sometimes, a cost can become an expense, effectively moving from a company's balance sheet to its' income statement. This happens when the cost of purchasing an asset to benefit business operations evolves into an expense of doing business.
Related: What Is Cost Accounting?
Costs and expenses for tax purposes
Costs do not directly affect taxes. But the cost of an asset can be used when determining depreciation expenses for year-end thereby reducing income for tax purposes. If a company expects an asset to be in use for more than 12 months, or past the accounting end-of-year balance sheet date, it must allocate the cost or depreciate the asset to future financial periods.
Depreciation is a non-cash expense. It is the cost of an asset spread over its estimated “life” or the time-period throughout which it is expected to remain in use for the business. This accounting method has no bearing on how the asset was purchased, its current physical condition or its actual life.
Expenses, though, do have a direct effect on the business' income tax bill. Expenses, used to keep the company operating and producing revenue, are deductible on a business tax return. In application, this means that spending money can often save you money on taxes.
Some ways to equip your business and lower your tax debt by deducting expenses include:
Stocking up on in inventory and office supplies
Pre-pay insurance or rent payments, and professional subscriptions
Set-up a 401K plan for employees
Write off bad debts and damaged or obsolete equipment and inventory
Give year-end employee bonuses
Take advantage of bonus depreciation
Buy energy-efficient vehicles and property
Time expenses appropriately, taking into consideration yearly business profits and tax rates
It is always best to consult a qualified tax advisor to maximize qualified business deductions.
Read more: How To Report Business Expenses
Costs vs expenses
There are some easy comparisons between costs and expenses to help differentiate the two. Key differences are highlighted below:
Cost: Purchase of asset or an investment benefiting business operations
Expense: Regular, ongoing payment needed to do business
Cost: Reflected on the balance sheet
Expense: Reflected on profit-and-loss statement
Cost: Business asset
Expense: Needed to earn business revenue
Effect on profitability
Cost: Indirect impact on business profitability
Expense: Direct impact on business profitability
Cost: Costs incurred towards current assets have an impact on the company's current ratio or business liquidity (formula: (current assets)/(current liabilities))
Expense: No impact on a company's current ratio
Cost: Costs incurred towards non-current assets impact a company's capital structure or the way a business finances its' assets through a combination of equity, debt or hybrid securities
Expense: No impact on a company's capital structure
Cost: Fixed assets, prepaid expenses, inventory, etc.
Expense: Depreciation, interest, raw materials, etc.
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