Classification of Types of Expenses

• Shubhra Paul ACA is a partner at Arun & Company, Chartered Accountants.
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Classification of Types of Expenses

• Operating expenses.
• Administrative expenses.
• Selling and Distribution expenses.

Operating Expenses

• Operating expenses relate to a company's core activities, such as the cost of goods sold, administrative fees, factory supplies, direct labor and rent.
• These expenses are incurred from normal, day-to-day operations.
• Operating expense is deducted from revenue to arrive at operating income and managing these expenses ensures profit maximization.
• Reducing expenses too much can hurt the company's productivity.
• Examples of operating expenses include rent, wages, repairs, utilities expenses, depreciation, and amortization.

Administrative Expenses

• These are expenses that an organization incurs that are not directly related to a specific core function such as manufacturing, production, or sales.
• They are overhead expenses related to the organization as a whole, not individual departments.
• Administrative expenses support the overall functioning of a business.
• A level of administrative expenses will always be incurred as a necessary part of operations.
• They are often among the first identified for budget cuts due to not directly impacting a company's main business functions.
• Management may allocate administrative expenses to business units based on a percentage of revenue, expenses, or other measures.
• Examples of administrative expenses include rent, utilities, insurance, executives' wages and benefits, depreciation on office fixtures and equipment, legal counsel and accounting staff salaries, and office supplies.

Selling and Distribution Expenses

• Distribution costs encompass all expenses a producer incurs to deliver a product from its production site to the end customer's location.
• For a manufacturer, this includes expenses incurred to make product delivery possible to the customer's location, whether retailer, wholesaler, or the final customer.
• These expenses include costs such as shipping , packing, transport, storage and insurance.

Audit Objectives

• An audit of expenses assesses whether company expenses were necessary and aligned with business policies.
• Auditors gather evidence to reach a conclusion on this matter.
• The audit ensures expenses are reasonable, accurately recorded, and efficiently managed.
• Accuracy is crucial as it affects profit statements if expenses are understated or overstated.

Audit Procedures

• Completeness: Ensure all expenses that should have been recorded are actually recorded.
• Cut-off: Verify expenses are recorded in the correct accounting period.
• Accuracy: Ensure all expense transactions are recorded correctly.
• Occurrence: Confirm recorded expenses actually occurred and are relevant to the client.
• Classification: Check all expenses are properly classified.

Auditing Procedures for Salaries & Wages include

• Verifying data across various accounts and software systems, that is used to manage employee data.
• Ensuring employees appointed for part-time work are not incorrectly paid for full-time work.
• Typical control objectives of wages and salaries includes to ensure: payments are for work done and made to valid employees.
• Payments are authorized and complying with employment terms and calculation.
• Furthermore payments should recorded correctly and any tax compliance is performed according to regulation.

Evaluation of the Internal Control System

• Assessing whether employees can be paid without working.
• Whether wages and salaries can be paid to fictitious employees.
• Whether wages can be paid without approval.
• Confirming the chances of errors in wage calculations or incorrect wage cost recordings

Auditing Procedures for RENT

• Involves reading the rent agreement and note important term and conditions such as Rent expense, security deposit amount, validity period .
• Examination to determine whether rent is recorded as and when rent accrued.
• Verification of the authenticity of rent receipts and whether it belongs to the tenant.
• Determine if there is any advance payment, including its adjustment against rent expense.
• Also to reconcile payments made via bank statements.
• Ensuring any rent increase complies with the agreement.
• Verification of the rent expense for proper accounting such as prepaid and outstanding.

Auditing Procedures For Utility Bills

• Reviewing the Numbers in a Utilities Expense Audit.
• Looking at Rate Structures.
• Monitoring Growth Trends.
• Researching Tax Exemptions.
• Checking for Clerical Errors.

Test of Details of Expenses Vouching Objectives

• To verify business transactions are accurately recorded in the books of accounts.
• To confirm that recorded transactions have appropriate documentary support.
• To ensure all documentary evidence is genuine, relevant to business activities, and free from errors or fraud.
• To confirm proper voucher processing through all stages of the Internal Check System.
• To verify the appropriate recording of entries based on capital and revenue nature
• Aim to check the accuracy of accounting transactions.

Examples of Vouchers for Test of Details of Expenses

• For Sales: Sales order, sales invoice, goods outward register, cash receipt, bank pay-in-slip.
• For Purchase: Quotations, purchase orders, purchase bills, goods inward register.
• For Cash Payments: Demand note, cash receipt, cash memo.
• For Cash Received: Duplicate or carbon copy of cash receipt, contracts, and correspondence with payee
• For BankPayments: Cheques, counterfoils, bank statements
• For Payment received through Banking Channels: Bank deposit slip, bank statements.

Analytical Procedures-Variance of Expenses through Cost Variance

• Cost variance analysis is a tool used to check costs compared to budgeted numbers.
• Its steps include:
  • Calculate the difference between actual and budgeted spending.
  • Investigate the reason for the gap.
  • Compile the information and talk to management.
  • Develop a plan to align costs with the budget.

Cut Off in Audit

• Cut-off testing checks if accounting entries are logged in the correct periods.
• The goal is to confirm the reported profit or loss aligns with the period it claims to represent.
• Cut-off testing validates transactions recorded correspond to activities within the specified accounting period.

Auditors Procedure for Cut-off Testing

• Revenue requires auditors to review the last invoices with goods dispatched notes of the accounting period
• Reconcile the goods dispatched notes and the invoices of the auditee
• Invoices and goods must match to apply this audit to property, plant and equipment – PPE

Auditors Procedure for PPEs must include

• Request purchase invoices and delivery notes for the assets under consideration during auditing
• To ensure date of capitalization is correct and depreciation begins on time: the delivery note and purchase invoices require the same capitalization.

Auditor's Cut-off Testing for Expenses

• Request last three expenses, then review invoices and receiving notes for last three expenses.
• Ensure accounting system is updated on same date as invoices and should fall in the period under reporting.
• If the dates on purchase invoices and receiving notes match the posting date, it can assure proper expense recording according to the appropriate period.

Understand the different types of expenses in accounting, including operating, administrative, and selling & distribution costs. Operating expenses stem from core business activities and are crucial for calculating operating income. Learn how managing these expenses impacts a company's profitability.