Financial Statement Series: Income Statement, Part 8, Expenses

Rylan Kaliel
May 30, 2025
5 min read

Updated: Jun 20, 2025

Stack of files with Canadian currency notes emerging, alongside a calculator and coins on a wooden surface, conveying financial matters.

What are Expenses on the Income Statement

In the prior blog we talked about what revenue was and how it is represented on the Income Statement. In this blog we will look at the counter part to the revenue which is the expenses. Expenses are basically the costs incurred in the process of earning revenue. Think of your business as a living organism. Just as your body needs vitamins and minerals to function efficiently, your business needs a steady inflow of cash to cover its operational costs. If you're not aware of what these costs are and how they impact your bottom line, you may find yourself in financial difficulty, unable to keep the lights on, pay your staff, or produce your goods or services.

The expenses are separated in the income statement into two distinct categories.

Direct expenses and indirect expenses which will discuss in full below.

Direct Costs (COGS)

Direct costs, also known as Cost of Goods Sold (COGS), are expenses directly tied to the production of goods or services. For example, if you’re running a bakery, the flour, sugar, and the delightful chocolate chips that go into your cookies are all direct costs. Think of direct costs as the ingredients in your grandma’s secret recipe – necessary and irreplaceable.

Examples of Direct Costs

Raw Materials: The ingredients for your products, like flour and sugar in a bakery, wood for a furniture maker, or fabric for a clothing designer. Additional examples include metals for a jewelry maker, paint for an artist, and electronic components for a tech gadget manufacturer.

Labor: Wages paid to employees who directly produce goods, like bakers kneading dough, carpenters crafting tables, or seamstresses stitching dresses. This also includes technicians assembling hardware, chefs preparing meals, and artists painting canvases.

Manufacturing Supplies: Items used in the production process, such as baking tins, woodworking tools, or sewing machines. Other examples include molds for a ceramics studio, kilns for a pottery maker, and brushes for a painter.

Inventory: The stock of finished goods ready for sale, like freshly baked bread, handcrafted chairs, or ready-to-wear garments. Additionally, this could include wrapped gifts for a gift shop, bottled perfumes for a fragrance brand, or packaged devices for an electronics store.

Indirect Costs

Indirect costs are expenses that aren't directly tied to the production of goods or services but are necessary for business operations. These costs support overall business activities and can be harder to allocate to specific products or services.

Examples of Indirect Costs

Rent: The cost of leasing commercial space where production, storage, or administrative work takes place. This could be a bakery shop, a workshop for a carpenter, or a studio for an artist.

Utilities: Expenses for electricity, water, heating, and cooling that keep the business environment functional. For example, powering ovens in a bakery, lighting in a workshop, and climate control in a studio.

Office Supplies: General supplies used in administrative tasks, like stationery, printers, and paper. This also includes software subscriptions, office furniture, and cleaning supplies.

Insurance: Various types of insurance coverage, such as liability, property, and health insurance. For example, protecting a bakery against fire damage, covering a carpenter’s workshop from theft, or ensuring health coverage for employees.

Marketing and Advertising: Costs related to promoting products or services, such as online ads, brochures, and social media campaigns. This also includes event sponsorships, influencer partnerships, and public relations efforts.

Salaries: Wages paid to non-production staff, such as administrative personnel, sales representatives, and marketing managers. Additionally, this includes HR professionals, accountants, and customer service teams.

Depreciation/amortization: Depreciation and amortization are non-cash expenses that allow businesses to allocate the cost of tangible and intangible assets over their useful life. These expenses reflect the wear and tear of physical assets or the gradual consumption of intangible assets, providing a clearer picture of the true cost of operations.

How Depreciation is Calculated

Depreciation applies to tangible assets such as machinery, buildings, or vehicles. Several methods are commonly used, including:

Straight-Line Method: This is the simplest method, where the asset's cost is divided evenly over its estimated useful life. For example, a $10,000 machine with a 5-year lifespan would incur $2,000 in annual depreciation. This method is described in detail in our Long Term Assets blog post.
Declining Balance Method: This method calculates depreciation as a fixed percentage of the asset's book value each year, resulting in higher expenses during the earlier years. For instance, if the same $10,000 machine mentioned above depreciates at 20% annually, the expense decreases over time as the book value decreases. This method is described in detail in our Rental Income blog post.
Units of Production: This approach ties depreciation to asset usage. If a manufacturing machine is expected to produce 100,000 units over its lifespan, and it produces 20,000 units in one year, depreciation for that year equals 20% of the machine's cost.

How Amortization is Calculated

Amortization, on the other hand, applies to intangible assets like patents, copyrights, or trademarks. It usually employs the straight-line method over the asset's useful or legal life. For example, if a business acquires a patent for $50,000 with a validity of 10 years, the annual amortization expense would be $5,000.

Examples

Examples of depreciation include reducing the value of physical items like a delivery truck, factory equipment, or office furniture over time due to wear and tear. For amortization, examples include spreading out the cost of intangible items such as a software license, a franchise agreement, or a customer list acquired during a merger, across their useful lifespan.

Please note that on the Income Statement you will only include the depreciation and amortization for that specific period in the income statement. For example, let’s say you are preparing the income statement for June - August then you would include only the amortization/depreciation expense for those 3-months.

Summary

Understanding the distinction between direct and indirect costs is vital for managing your business’s finances effectively. It enables you to identify where your money is going and how it influences your overall financial health. By keeping a close eye on these expenses, you can make informed decisions that enhance your profitability and ensure the sustainability of your operations.

Your business's success depends on a sound financial foundation. Recognizing and controlling these expenses will not only help you maintain the necessary flow of cash but also prevent financial difficulties that could jeopardize your operations. Remember, it’s essential to treat your business's finances with the same diligence and care as you would your own health.

For expert guidance and support, reach out to KLV Accounting. Our team is dedicated to helping you understand and manage your expenses efficiently. Contact us today for any accounting needs or questions about the segment above.

In the next blog we will discuss the relationship between Income Statement and the Balance Sheet.

KLV Accounting, a Calgary-based accounting firm, is here to help. Contact us today to enhance your financial strategy, minimize your taxes, and drive business success! For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.