What is cost
In the realm of accounting, the terms “expense” and “cost” are often used interchangeably, leading to confusion. This article aims to clarify the distinction between the two and shed light on their significance in financial reporting.
A cost is essentially an expense recognised based on consumption. This recognition occurs in the period in which a product or service is utilised. Unlike expenses, costs are recorded when the purchased item or service is actively put to use.
Expense vs. cost
To differentiate between an expense and a cost, it’s crucial to understand their timing and application.
When you acquire a product or service, it is termed an expense until the moment you use it. Subsequently, once consumed, it transforms into a cost. This fundamental distinction emphasises that the act of purchase is categorised as an expense, while utilisation is labelled as a cost.
To illustrate this concept, consider an individual who registers and pays for a seminar three months before its commencement. The act of payment represents an expense, and upon completion of the seminar, it is then recognised as a cost.
In instances where the time gap between expense and cost is minimal, such as buying lunch for an office, the transition from expense to cost occurs swiftly. The moment the lunch is consumed, it is considered a cost, exemplifying that this transition is not contingent on a prolonged timeframe.
Application in business
In a business setting, particularly in the production of goods like ice cream, both fixed and variable costs are prevalent. Fixed costs, such as rent and salaries, are predetermined and known in advance. On the other hand, variable costs, like ingredient expenses, may pose challenges in accurate calculation.
For instance, if a company purchases ingredients worth $10,000 in one month but only utilises 75 per cent, the remaining $2,500 is recognised as a cost in the subsequent month.
This underscores the importance of precise accounting practices in reflecting the true financial status of a business.