Here we detail about the two types of revenue expenditures, i.e., (i) Direct Expenses and (ii) Indirect Expenses.
The above diagram presents the circular flow of production and a dotted line demarcate the expenses into direct and indirect. The expenses falling above the dotted line are direct and expenses below the dotted line are indirect in nature.
(i) Direct Expenses:
Direct expenses are the expenses incurred by trading concerns on purchases of goods and bringing them to saleable conditions. In the case of manufacturing concerns, direct expenses also include the cost of conversion of raw material into finished products.
Direct expenses include the following types of items:
(a) Wages / Direct Wages/ Productive Wages/Wages and Salaries:
Workers, who are directly engaged in the production of goods, get wages for loading, unloading and production of goods. The amount paid to these staff is also known as direct wages or productive wages. Salaries paid to the staff of factory should also be treated as direct expense.
(b) Carriage / Cartage / Freight / Carriage Inwards / Cargo Expenses / Shipping:
Transport expenses incurred for bringing the material purchased to the place of the business enterprise fall under these categories and treated as direct expenses.
(c) Import Duty / Customs Duty / Dock Charges:
These are the expenses which have to be incurred when goods are imported. These are incurred on the goods which are purchased with the intention of resale, so these are included in the category of direct expenses.
Octroi duty is to be paid to the municipal corporation for bringing the goods from one municipal limit to another municipal limit. As these expenses are incurred for purchasing the goods, they fall under the category of direct expenses.
(e) Fuel / Motive Power / Gas / Water:
These items of expenses are incurred in the production process for running the machines at factory and so are included in the category of direct expenses.
Royalty is the payment in form of rent, paid to the owner of some assets such as patents, copyright, land etc. When the rights of the owner are used, he is paid for it. This amount is called royalty. Royalty can be paid on the basis of production or on the basis of sales. When it is paid on the basis of production, it is to be treated as direct expenses, for example, royalty paid by the lessee of coal mine to the owner of a coal mine, for taking out coal from the mine, is to be treated as direct expenses. However, when it is paid on the basis of sale, it is to be treated as indirect expense, for example, royalty paid to the authors by the publishing companies.
(g) Packaging Material and Packaging Charges:
The expenses incurred for packaging material may be direct or indirect expense. When such expense is necessary for handling or making the goods saleable, it should be treated as direct expense, for example, tins used for containing oil, cartons used for packing T.V sets etc. In this case, cost of tins or cartons should be treated as direct expense because without incurring expenses on tins or cartons, oil or T.V. sets cannot be sold.
When packing expenses are incurred with the intention of transporting goods from one place to another, such expenses incurred for packing the goods in containers and big boxes or expenses incurred for packing the goods in fancy packing or gift packing should be treated as indirect expenses.
(h) Commission on Purchases:
Sometimes, the business enterprise has to pay some commission or brokerage for purchasing the goods. In that case, such amount should be treated as direct expenses.
(ii) Indirect Expenses:
Indirect expenses are those expenses which are incurred in connection with selling and distribution of goods and general administration of the business enterprise.
Indirect expenses include the following items:
(a) Salaries/Salaries and Wages:
The amount paid to the administration, godown and warehouse staff for the services provided by them for running the business is included in the term salaries. These are of indirect nature. It is worth mentioning that in the normal course, the employees are paid net salaries, but the gross amount of salary is to be shown on the debit side of Profit and Loss Account. The gross salary includes Income Tax, Provident Fund and Gratuity etc. To get the gross figures of salaries to be debited to the Profit and Loss Account, the deduction of Income Tax or Provident Fund etc., should be added back to it.
Similarly, if perquisites like rent free accommodation, meals, uniform, medical facilities are provided to the employees as a part of salaries, the monetary value of such perquisites should also be added to the item salary and debited to Profit and Loss Account.
(b) Kent, Rates and Taxes:
The amount paid towards rent for godown and office, municipal rates and taxes are included under this head. Being an indirect expense, this should be debited to Profit and Loss Account. However, rent paid for the factory should be treated as direct expense and debited to Trading Account. The point to be noted here is that the gross amount, i.e., before deducting the tax deducted at source, should be considered.
Interest, if shown as debit balance in the trial balance, is an indirect expense. This figure represents the amount paid on loans, bank overdraft, renewal of bills of exchange etc. This expense is debited to the Profit and Loss Account. However, if it is shown on the credit side of the trial balance, it is an indirect income and credited to the Profit and Loss Account.
Sometimes, business transactions are completed through the services of agents. In that case, commission has to be paid. It is an item of indirect expense. The amount shown on the debit side of the trial balance represents the amount paid as commission and debited to the Profit and Loss Account. However, if it is shown as credit balance in the trial balance, it should be credited in the Profit and Loss Account.
This head includes the expense which is incurred for keeping machineries, furniture and fixtures etc., in working condition. This expense is debited to Profit and Loss Account. It is worth mentioning here that the expenditure which increases the capacity of the business is capital expenditure and shown as an asset in the balance sheet.
The apportionment of depreciable amount of a fixed asset and charging the same into revenue during the useful life of that asset is known as depreciation. Through this process, depreciation expenses can be matched with the revenue generated from the use of asset. This estimated value is debited to the Profit and Loss Account.
(g) Trade/Sundry/Miscellaneous Expenses:
Some expenses, which are of small amount, are not classified and booked under specific heads. They are combined together and are called Sundry Expenses. They are also termed as ‘Miscellaneous Expenses’ or ‘Trade Expenses’. These are to be debited in the Profit and Loss Account.