Liabilities Aren’t Expenses!
Now we’re not making any sense, right? Liabilities and expenses are both things you have to pay for – why aren’t they the same, you might wonder.
Recently we have been taking a look at expenses - what they are (costs of operating the business), how they may be used to…adjust…corporate earnings (by varying estimates and accounting choices), and how they relate to loan payments (paying down principal is NOT an expense, but interest is an expense). So what about liabilities?
Liabilities are what we owe - to lenders and anyone who has sold us goods or services on credit - suppliers, professionals, etc. If we pay for our expenses when they come due, or in advance (we pay the rent when it’s due, we buy inventory for cash, we prepay for insurance), then those expenses never become liabilities. If we’ve paid for them on credit, then those expenses generate liabilities because we still owe them, not simply because they are expenses. And if we have a liability because we need to repay money we’ve borrowed, then as discussed in a recent article, those repayments are not expenses.
Looking at it another way, expenses are items that happen in time and liabilities are persistent. An expense happens in a moment - the rent comes due, interest comes due, we use a service, or it’s payday. We then add the expenses to our Income Statement (a/k/a P&L Statement, or Profit & Loss). If we pay for them at the time, or prepaid for them, then that’s it – they never become liabilities. If we haven’t paid for them yet, then they create liabilities related to those expenses – but those liabilities are not the expenses themselves. Liabilities persist for a period of time – they’re created when the bill comes due, or we borrow money, and they go away once the bills are paid or the debt is repaid.
More confused than ever? We hope not! It sounds a lot more complicated than it really is. Stay tuned as we look further at Expenses vs. Capitalization and the true nature of expenses. Better yet, sign up for one of our upcoming live, online, or on-demand courses for a more complete understanding!