«Expense» and «cost» are often used interchangeably, leading to confusion.
In essence, a cost is an expense that is recorded according to consumption. This acknowledgment happens during the course of using a good or service. Unlike expenses, costs are recorded when the purchased item or service is actively put to use.
Expense vs. cost
It is important to understand timing and application when looking at the difference between expenses and costs.
A product or service is an expense until you use it. Once consumed, it transforms into a cost. This shows that buying something is considered an expense, while using it is termed a cost.
Example scenario
Imagine someone who signs up and pays for a seminar three months in advance. The payment is an expense, and after the seminar takes place, it becomes a cost.
The shift from expense to cost can happen very quickly, for example when you buy lunch for the office. When you eat the lunch, it shifts from being a expense to a cost. Therefore, the change does not necessarily depend on a long period of time.
Application in business
In the production of goods like ice cream, both fixed and variable costs are prevalent. Fixed costs, such as rent and salaries, are known in advance. Variable costs, such as the cost of ingredients, can be tricky to calculate accurately.
If your company purchases ingredients worth $10,000 in one month but only utilises 75 percent, the remaining $2,500 is recognised as a cost in the later month.
This shows the importance of precise accounting practices. It reflects the true financial status of a business.