Expenses refer to amount of money spent in a period which
helps meet the day to day needs of a business. Asset is future benefit at a
particular point of time.
Now the best way to understand the concept of
capitalization and expenses is to draw an analogy with how pastries are sold in
the market. The bakery shop bakes a big cake. When the customer walks into the
shop and demands for a pastry, the baker cuts a chunk of the cake and sells it
to the customer. Same happens when an
asset is expensed.
Examples:
·
A machinery is purchased for the
purpose of manufacturing goods. When we purchase the machiney it is shown as an
asset. In the period the goods are manufactured we show the “usage of machinery”
as depreciation and treat it as an expense. Hence, every accounting period the
size of our cake a.k.a machinery in the balance sheet decreases as a chunk of
it goes in the income and expense account.
·
Inventory or Closing Stock refers to
the goods not sold at the end of the accounting period. Hence, here closing stock is the “cake”, when
we sell the goods the “pastries” a.k.a. cost of goods sold is expensed is expensed.
·
Patents and Goodwill are intangible assets
when we utilize the benefits from the same it is expensed out as amortization.
Author: Abhishek Sinha
Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +
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