How to Read a Financial Report: Wringing Vital Signs Out of the Numbers

Chapter 7. OPERATING EXPENSES AND ACCOUNTS PAYABLE

Recording Expenses Before They Are Paid

Please refer to Exhibit 7.1 at the start of the chapter, which highlights the connection between selling, general, and administrative expenses in the income statement and the second of the two accounts payable components in the balance sheet. Recall from Chapter 6 the two sources of accounts payable—from inventory purchases on credit, and from expenses not paid immediately. Chapter 6 explains the connection between inventory and accounts payable. This chapter explains how expenses drive the accounts payable liability of a business.

Every business in the world has a wide variety of operating expenses. The term "operating" does not include cost of goods sold, interest, and income tax expenses. Also, in our example, the company's depreciation expense is reported separately. All other operating expenses are combined into one conglomerate account labeled "Selling, General, and Administrative Expenses" (see the income statement in Exhibit 7.1). This expense title is widely used by businesses, although you see variations of this title.

Day in and day out, many operating expenses are recorded when they are paid, at which time an expense account is increased and the cash account is decreased. But some operating expenses have to be recorded before they are paid—which is the focus of this chapter.

"Operating expenses" is the convenient term I use in the collective sense to refer to many different specific ...