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About this lesson
Learn about categorizing expenses
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Quick reference
Expenses (and What are Not Expenses)
The IRS defines business expenses as costs that are both reasonable and necessary for the operation of your business. They are the purchases made in the running of your business that help in generating income.
Examples of Business Expenses:
- Business licenses
- Business insurance
- Rent for business property
- Business-related software subscriptions
- Employee wages and salaries
Expense accounts are named or listed using broad categories, for instance:
- Dues and Subscriptions: Generalized, not detailing every provider
- Telephone and Internet: Grouped, without itemizing every service
- Wages and Salaries: Summarized, without listing individual employees
What is not an expense tracked on the profit and loss for a sole prop business?
- Personal Mileage: For sole proprietors, business-related mileage is reported on tax returns but is not tracked as a business expense
- Owner’s Draw: Money withdrawn from the business for personal use is not a business expense
- Taxes Owed: Amounts due to the IRS from the sole proprietor are not a business expense
Chart of Accounts
This is the complete list of all the accounts a business uses, including income accounts, cost of goods sold, expense accounts, and balance sheet accounts. It should be updated as your business grows and changes.
Helpful Links
- IRS Publication 535 on the IRS website provides detailed information about what constitutes a business expense.
- 00:04 In this lesson, I'm going to review expenses.
- 00:07 The IRS defines expenses as expenses that are both reasonable and
- 00:12 necessary to run the business.
- 00:15 If you'd like more specific information about this,
- 00:19 you'll want to go to the irs.gov website and look for Publication 535.
- 00:24 Examples of business expenses are things such as the business license,
- 00:31 business insurance, rent, software, staffing.
- 00:36 I'm going to provide some real-world examples, or
- 00:39 as real-world as the sample companies get.
- 00:43 Every company will identify the level of detail that it wants when tracking
- 00:48 the income and the expenses.
- 00:50 In this sample company, there's advertising, automobile,
- 00:55 equipment rental, job expense, you get the idea.
- 00:59 When looking at the profit and loss for the Zero Sample company file,
- 01:03 you'll notice that there's some familiar expense categories or accounts, and
- 01:08 there's some new ones.
- 01:09 I'm showing you this so that you can see that the business can select the level
- 01:14 of detail they want for their expenses, but still broad categories are used.
- 01:19 Broad categories such as dues and subscriptions, but
- 01:23 not the name of every provider in which that they pay dues and subscriptions to.
- 01:29 Telephone and Internet, but not the name of the telecom.
- 01:32 Wages and salaries, but not the names of the team members.
- 01:37 The expenses are going to be broad categories that give summary information.
- 01:42 Our make-believe Fresh Books business doesn't have a lot of activity going on.
- 01:47 When reviewing their expenses, they have advertising,
- 01:50 car and truck, with some subaccounts underneath that, and that's it.
- 01:55 Sometimes a business is small, and when they're just starting out,
- 01:59 they don't have a lot of expense accounts.
- 02:02 It's common that as a business grows and identifies the accounts it wants to track,
- 02:07 it'll begin to add those to the chart of accounts.
- 02:10 The chart of accounts is the listing of all of these accounts as well as
- 02:14 the balance sheet accounts.
- 02:16 If I'm going to review with you what an expense is,
- 02:20 I also need to review with you what is not an expense.
- 02:24 The following examples are based on conversations that I have with sole
- 02:28 proprietors.
- 02:29 The first conversation is the mileage.
- 02:32 When a sole proprietor files their annual tax return with the IRS,
- 02:36 they're going to indicate the mileage that they had for business.
- 02:41 This is going to be something between the human and the IRS.
- 02:44 It is not something tracked as a business expense.
- 02:48 When the sole proprietor takes money out of the business and
- 02:52 transfers it to their personal account, that is typically not a business expense.
- 02:58 When the sole proprietor owes the IRS money, that's not a business expense.
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