Understanding the difference between liabilities and expenses is crucial for accurate financial reporting and effective decision-making in business. While both affect a company’s bottom line, they impact financial statements differently.
This guide will break down each concept, show how to record them correctly, and also explain how you streamline the entire process of expense management.
Liability vs Expenses: An Overview of Differences
In accounting, liabilities and expenses represent two distinct financial concepts.
Liabilities refer to debts or obligations a business owes, while expenses represent the costs incurred to generate revenue.
Liabilities often appear on the balance sheet, affecting the company’s assets and equity, while expenses appear on the income statement, directly impacting net income.
Let’s explore these concepts further.
What Is a Liability?
A liability is an obligation or debt a business must pay in the future. It can arise from loans, services received but not paid for, or any other financial obligation. Liabilities are essential for understanding a company’s financial health and future cash flow needs.
Types of Liabilities
Liabilities come in various forms, each with a unique impact on a company’s finances.
Current Liabilities
These are obligations due within a year, such as accounts payable, short-term loans, and accrued expenses. Managing current liabilities is essential for maintaining smooth cash flow.
Non-Current Liabilities
Non-current liabilities are long-term obligations that extend beyond a year, such as bonds payable or long-term leases. They impact a company’s long-term financial planning.
Contingent Liabilities
Contingent liabilities are potential obligations that may arise depending on a future event, such as warranties or pending lawsuits. They are only recorded if the event is likely and the amount is estimable.
Liabilities vs Assets
While liabilities represent what a company owes, assets represent what it owns or controls, which provides economic value. Assets and liabilities are opposite sides of the balance sheet equation, with assets driving business growth and liabilities often funding that growth.
When Should I Classify Something as a Liability?
It can sometimes be challenging to determine if a financial commitment qualifies as a liability. A simple rule is: if your business owes a debt, has received services or products without payment, or has a contractual obligation to pay, it should likely be classified as a liability.
For example, unpaid rent or payroll can be liabilities until cleared.
How to Record Liabilities?
Recording liabilities involves documenting them as credits in the balance sheet and corresponding debits in an appropriate account (such as cash or assets). For example, if you take out a loan, record it as a credit under “Loan Payable” and debit your cash account by the loan amount.
Example of Liabilities
Let's look at a historical example using Apple’s 2022 balance sheet. The current/non-current liabilities are are listed under the liabilities and shareholder’s equity section.
What is an Expense?
Expenses are costs incurred during regular business operations that help generate revenue. Unlike liabilities, which represent obligations, expenses signify the cost of resources consumed in generating income.
Types of Expenses
To better understand expenses, let’s explore some primary categories:
Cost of Goods Sold (COGS)
These are direct costs related to producing goods sold by a company, including raw materials and labor. COGS directly impacts gross profit.
Selling, General, and Administrative (SG&A) Expenses
These include operational expenses like salaries, office supplies, and marketing costs. SG&A expenses contribute to operating income calculations.
Operating vs Non-Operating Expenses
Operating expenses relate to the core business operations, while non-operating expenses include costs outside typical business activities, such as interest on loans or losses from investments.
Here’s a glimpse of Apple’s Operating expenses from their second-quarter results in 2022:
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Capital Expenditures vs Regular Expenses
Capital expenditures (CapEx) are investments in long-term assets like property or equipment, while regular expenses are short-term operational costs. CapEx appears on the balance sheet, while regular expenses affect the income expenses.
Liabilities vs Expenses: Impact on Financial Statements
Understanding how liabilities and expenses affect financial statements is crucial for accurate reporting. Liabilities are recorded on the balance sheet and impact assets and equity.
Expenses are recorded on the income statement, directly affecting net income and, subsequently, retained earnings on the balance sheet. Misclassifying expenses or liabilities can distort a company’s financial health, affecting investor confidence and decision-making.
How to Record Expenses
To record expenses, debit the expense account and credit the corresponding asset or liability account, depending on the payment method. For example, if you pay cash for office supplies, debit the “Office Supplies Expense” and credit “Cash.” This practice ensures your income statement reflects all business costs accurately.
With Fyle, you can streamline this process significantly. Instead of manual entry, Fyle’s platform allows employees to submit expenses directly through apps like Text Messages, Gmail, Outlook, and Slack, making expense reporting quick and effortless.
Once submitted, Fyle’s system automatically extracts, codes, and tracks expenses in one place, ensuring consistency and accuracy in your financial records.
Why Proper Classification Matters in Business Accounting
Accurate classification between liabilities and expenses is essential for clear financial records, compliance, and better business decision-making. Misclassifications can lead to skewed financial ratios, impacting a company's perceived profitability, liquidity, and overall financial stability.
How Fyle Automates Expense Management
Managing expenses manually can be time-consuming and error-prone. Fyle simplifies the process with automation and seamless integration into accounting software, making expense management efficient and accurate.
- Effortless Receipt Submission: Employees can submit receipts instantly through Text, Gmail, Outlook, Slack, or email forwarding, as well as Fyle’s mobile and web apps.
- Real-Time Credit Card Expense Tracking: Get real-time notifications for business credit card transactions, and receipts are easily matched to card transactions, saving hours in manual reconciliation each week.
- Streamlined Mileage and Per Diem Management: Fyle automates tracking and reimbursement for mileage and per diems. Employees can record mileage through Google Maps, add stops and duplicate routes, or set up recurring mileage expenses. Admins can also configure mileage rates according to IRS guidelines.
- Seamless Accounting Software Integration: Fyle syncs fully-coded expense and receipt data with accounting platforms like QuickBooks Online, Sage Intacct, Xero, Sage 300 CRE, and NetSuite, ensuring accurate, up-to-date financial data across systems.
In Conclusion
Understanding liabilities and expenses, their differences, and their impact on financial statements is fundamental to effective business accounting. Proper classification not only provides clarity but also supports accurate financial reporting and compliance.
Fyle simplifies expense management with automation, ensuring seamless categorization and efficient tracking. By accurately distinguishing between liabilities and expenses, businesses can achieve a clearer financial picture and make informed decisions with confidence.
