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In the context of accounting we could define an expense as cost incurred. That definition of expense does not help to understand the difference between expense and cost as we do not know what cost means. But the addition of the word incurred helps That means that in order to qualify something as an expense you need to ‘feel the pain’ of the cost. For instance, because you paid for it. Or because it should be recognized in accounting and thereby lowers the profit. Expenses therefore could be defined as recorded/incurred cost according to tax and accounting guidelines.

The meaning of the word cost is broader. The primary interpretation is the monetary one, money spent to get something. Very similar to expense. However according to Google cost could also refer to … effort, loss, or sacrifice necessary to achieve or obtain something. And this is where things start to become interesting.

Let us first discuss the word something. Basically, something could be anything but the first and most logical interpretation is that of a product or a service. But you can also think of something as money from a customer. In other words what do you need to do to get money from the customer. The point here is that the word something is open for interpretation. Other examples include activities and processes whereby you compare the output with the input and check what was needed to make this conversion happen. Sometimes this is a physical activity eg. cleaning the office or make an MRI scan. But sometimes this is just as simple as approving a document that changes the status from unapproved to approved.

For now, let us go back to product as the interpretation of something. What are the ‘… effort, loss, sacrifice necessary…’ to produce a product. Most people will think directly of Cost Of Goods Sold (COGS). And this is correct but falls mostly under the first interpretation of cost, money spent to obtain something. Let us dive a bit deeper.

Firstly, you have cost that have a direct one-to-one relationship with your finished product. When you are assembling a product the cogs have mostly a direct relationship with finished products eg. cost of four wheels to assembly a car.

Secondly you have cost that have a direct but not a one-to-one relationship. Think about the person who actually puts the wheels on the car. Let say this takes him 5 minutes per wheel. In total he needs 20 minutes to put on all 4 wheels. The worker is paid by the hour. There is a direct relationship, he works on the finished product, but not a one-to-one as we have to assign a portion of his hourly cost to the product in order to get a proper cost of the finished product. In this case we can interpret his time spent as the effort necessary to obtain/produce the product.

The above two categories are referring to direct cost of a product. But within an organization, there are also people and resources that are not directly linked to the finished product. Think of HR, IT, Legal. In these cases we talk about indirect departments/activities/staff and thereby indirect cost. More about indirect cost in one of my next posts.

The word sacrifice is a bit trickier. For early starters there is the risk that they forget to count in the value (=cost) of their own time to create and make their invention. Whether you want to translate your sacrifice in the price of not is another question. But it is important to understand the cost of your own time. Especially when you move on and an successor is needed.

In summary you could say that expenses refer to bookkeeping and financial statements whereas cost is linked to cost and management accounting.

Post Author: Frank van Vliet

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