A person’s gross income is used to determine how much they have to pay toward federal and state income taxes.
What is expensing?
Expensing is the method allowed under tax code Section 179 to claim an immediate deduction for a business expenditure.
Expensing involves wrapping expenditures in as operating costs rather than designating them as capital investments. As a result, these expenses are immediately deducted from income, rather than moving to the asset section of a balance sheet.
Expenses are recorded on the income statement and are calculated into a business’ operating expenses. Thus, expenses play negatively into a company’s profits and yearly bottom line.
Companies develop their own protocol, with appropriate guidance from generally accepted accounting practices, or GAAP, for determining what purchases are expensed. Often, purchases below a certain dollar amount are counted as expenses.
As you might deduce, expensing cannot be applied to every purchase for every business or even for the same purchase at different times during a business’ operation. When purchases cannot be expensed, they are capitalized and added to the balance sheet as an asset.
After a purchase is added to the balance sheet, it begins an appropriate yearly depreciation, as determined by its worth or company guidelines. Then, these expenses become deductions that can be claimed as yearly depreciation over the life of the asset.
The difference between expensing and capitalizing has gotten companies into trouble over the years. The WorldCom scandal in 2002 is a good example of what happens when decision makers put expenses into their balance sheets as assets.
When this happens, companies appear to be much more valuable than they actually are. Expenses on the income statement go way down, company value through valuation of assets goes up, and the yearly depreciation of assets is tax deductible.
All of these factors are enticing to corporations, which may notice a significant increase in stock prices when their financial reports are particularly attractive to investors.
The problem is that not every purchase can be capitalized. It becomes necessary for companies to make a distinction between purchases that can and ones that must be expensed. Failing to expense certain purchases can lead to unethical accounting practices and may land a company in legal trouble.
What expenses can you claim? Learn more about the business expenses that benefit your bottom line.