Difference Between Expenses & Withdrawals
Most expenses are financial transactions incurred for the earning of revenue during an accounting period. Throughout a revenue generating period, costs such as salary and wages expense, depreciation and advertising expense are incurred to facilitate the earning of the period’s revenue. U.S. accounting guidelines require in every accounting period that revenues and expenses be matched. Withdrawals are reductions of capital by the company’s owners and occur for a variety of reasons: an owner liquidates his interest, payment of company debt, or a return of capital is made. A reduction in capital will cause a similar reduction in cash or other asset account.
Expenses reduce revenues. They comprise all the cost activity that takes places to earn revenue for the period. Since expenses are usually incurred to produce revenue, they reduce gross revenue to arrive at net income for the period. When expenses are covered, the company is said to “break even”; a profit is earned when excess revenue beyond the period’s expenses is earned.
Expenses include cost items such as wages and salary for the company employees; direct materials, direct labor and manufacturing overhead for products sold; and advertising expense for the company’s products and/or services. Revenue-related expenses and other period expenses, such as depreciation of fixed assets and expensing prepaid insurance, are listed on the income statement.
Capital withdrawals can occur in sole proprietorships (non-public private companies) or partnerships (non-public companies with two or more partners) and other similarly-organized business structures. Withdrawals can reduce a single owner’s capital or the capital of all owners, depending on the nature of the withdrawal and the existence of an agreement that specifies details on how withdrawals should be handled. When a withdrawal is recorded, a corresponding asset account, usually cash, will be reduced by the amount of the withdrawal.
Examples of some types of capital withdrawals include transfers of an owner’s interest, payment of a partner’s debt or partnership obligations, and withdrawal of a partner or owner from the business. When owners or partners share in the business’ losses, this will reduce their capital accounts by their share of the loss, similar to when a withdrawal takes place.