How to Read a Financial Report, 10th Edition

11OPERATING EXPENSES AND ACCOUNTS PAYABLE

Recording Expenses before They Are Paid

Please refer to Exhibit 11.1, which highlights the connection between selling, general, and administrative expenses, and research and development expenses (collectively referred to as operating expenses) in the income statement and the second of the two accounts payable components in the balance sheet. Recall from Chapter 8 the two sources of accounts payable: inventory purchases on credit and expenses not paid immediately. Chapter 8 explains the connection between inventory and accounts payable. This chapter explains how expenses also 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. In our example, the company’s depreciation and amortization expense is reported separately. All other operating expenses are combined into two conglomerate accounts. The first is selling, general, and administrative expenses, and the second is research and development expenses. (See the income statement in Exhibit 11.1.) These expense titles are widely used by businesses, although you certainly see variations.

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 ...