Cost

What it means

A cost is a decrease in economic benefit in the accounting period - materials consumed, a service, wages, depreciation, interest. It is not the same as an outlay: the cost arises when something is consumed, the outlay when it is paid.

That is why an invoice paid in January can be a December cost, and an annual insurance premium paid in one go is spread across twelve months through accruals and deferrals.

Not every outlay on a purchase is a cost either. Buying tangible fixed assets swaps cash for an asset on the balance sheet, and the machine becomes a cost gradually, through depreciation over the years it is used. Likewise goods or materials in stock under inventory method A become a cost only when they are sold or consumed.

How it works in practice

In the profit and loss statement costs are grouped by nature: purchases consumed, services, staff costs, taxes and fees, depreciation, financial costs. Sub-accounts give the finer breakdown.

For management a different split is more useful: fixed versus variable. The first is required for the statements, the second is what pricing and the break-even point need.

At each month end we add costs for which no invoice has arrived yet: energy, rent from a foreign landlord, services billed quarterly. They are booked as an estimated accrual at the expected amount, so the monthly result shows actual consumption rather than only what the post happened to bring.

What to watch out for

Not every cost reduces the tax base. A non-deductible expense is a cost in the books but is added back in the tax computation - so both views are maintained in parallel, not reconstructed in March.

A cost booked from the bank statement alone, with no invoice or contract, does not survive an audit. Without a proper accounting document there is no proof of what was bought or that it relates to the business, so the expense is excluded from the tax base and, for a VAT payer, the input deduction goes too.