Explanation and treatment of direct expenses

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 22, 2021

All direct expenses are recorded on the debit side of Trading Account. The detailed explanation of some direct expenses is as under:

Opening stock or opening inventory

The opening stock consisted of different types of finished goods in case of trading business. Whereas in case of manufacturing business opening stock consisted of raw materials, work-in-progress and finished goods. The unsold closing stock of the last year is the opening stock of the current year. However, a newly established business has no opening stock at the beginning of the first year. As the last year’s unsold closing stock is sold in the current year, therefore, the cost of opening stock will be the expense of the current year and it is recorded on top of the debit side of Trading Account.

Purchases

It is the balance of Purchases Account that appears on the debit side of the Trial Balance. It shows the total purchases made by the business during the accounting year. It includes both cash and credit purchases. Purchases are recorded on the debit side of Trading Account. If there are any purchases returns in the Trial Balance these must be deducted from the purchases. Only net purchases should be recorded on the debit side of Trading Account.

Carriage or Carriage In or Carriage Inwards or Carriage on purchases or Transportation Inwards

These are the expenses incurred to bring the purchased raw materials or goods at factory godown, shop or workplace. Generally, the term “Carriage” is used for the expenses paid on bringing the goods from one city to another within the county. These expenses are recorded on the debit side of Trading Account. Students should remember that carriage paid on goods sold is called Carriage Outwards and it is not a direct expense and should not be recorded in Trading Account rather it is recorded in Profit and Loss Account.

Cartage

These are also the expenses incurred to bring the purchased goods at godown, shop or work place. Generally, the term “Carriage” is used for the expenses paid on bringing the goods from one place to another within the same city. These expenses are recorded on the debit side of Trading Account. Students should remember that carriage paid on goods sold is not a direct expense and should not be recorded in Trading Account rather it is recorded in Profit and Loss Account.

Freight or Freight Inwards

These expenses are paid as a fare of ship or aircraft to bring the purchased goods from abroad. As these expenses are connected with the purchase of goods therefore, are recorded on the debit side of Trading Account.

Insurance in transit

These are the charges paid to the insurance company to cover the loss that may occur during the transit of goods purchased. As these expenses are incurred in connection with the purchase of goods, therefore, these expenses are considered direct and recorded on the debit side of the Trading Account.

Packing Charges

There are certain types of goods which cannot be sold without packing. Such packing becomes the part of the product and treated as a direct expense. For example ink, that cannot be sold without a bottle or sachet. These types of packing charges are debited to Trading Account. But on the other hand, if goods are packed for safe dispatch to the customers such as carton packing of medicine is not a direct expense and is debited to Profit and Loss Account.

Landing and Wharf Charges or Dock Charges

These are the charges which are charged by the port authorities on unloading the goods at dock or wharf. Such charges paid in connection with the goods purchased are considered as direct expenses and are debited to Trading Account.

Clearing Charges

Some imported goods are needed to be cleared at ports and airports. Expenses paid for the clearance of purchased goods are treated as direct expenses and recorded on the debit side of the Trading Account.

Import Duty, Excise Duty and Custom Duty

The government imposes different taxes in different names such as import duty, customs duty and excise duty etc on the import of goods from abroad. When these taxes are paid on bought goods, are considered direct expenses and are debited to Trading Account.

Octroi Duty

This tax is charged by the Municipal Corporation of a city when commercial goods enter its territory. When bought goods are brought from the jurisdiction of one Municipal Corporation to another then this type of tax is paid. If this tax is paid on bought goods, it is considered the direct expense and debited to Trading Account.

Wages, Salaries or Manufacturing Wages or Wages Productive or Factory Wages

In trading concerns, wages are the remuneration paid to the workers for loading and unloading the goods. If these wages are paid in connection with the goods bought, then these are treated as direct expenses and debited to Trading Account. In manufacturing concerns wages are paid to the workers who are directly engaged in the manufacturing process. These are also known as productive wages or manufacturing wages or factory wages. Productive wages are treated as direct expenses and should be debited to Trading Account.

Factory Rent, Factory expenses, Factory Insurance, Factory Rates, Factory light and heat

All expenses incurred in the process of manufacturing goods such as factory rent, factory insurance, and factory lighting and heating etc are called manufacturing expenses. As all these expenses are related to the production of goods, therefore, considered direct expenses and are debited to Trading Account.

Motive Power

Motive Power expenses such as fuel, gas, water and other energy are incurred for the running of machines which are used for the production of goods. These are considered direct expenses since these are directly related with the production of goods and are debited to Trading Account. Here students should remember that electricity used in administrative and sales departments should be debited to Profit and Loss Account.

Consumable Stores

Consumable stores such as lubricating oils (engine oils), grease and cotton waste are used to keep the machinery in proper working condition. As this machinery is used in the production of goods, therefore, value consumed of consumable stores is treated as a direct expense and debited to Trading Account.

Raw Materials

Some raw materials are directly used in the production of goods such as tallow used in the making of lubricants, soap and candles. Similarly, oilseeds are used in the production of edible oils and Banaspati Ghee. As these materials are directly used in production, therefore, expenses incurred on them are considered direct expenses and are debited to Trading Account.

Royalty

Royalty is just like a rent which is paid to use certain rights. A manufacturer or producer pays royalty to get the rights to produce certain articles which are belonged to others. For example, a publisher pays royalty to the author of a book to get the rights to publish it.
Similarly, a company pays royalty to the landlord to get the rights to derive oils and gas from the land. It is also paid to a patent holder inventor by a manufacturer to get the rights to manufacture that certain product. Royalty is paid on production basis and on sales basis. If it is paid on production basis then it is considered direct expense and debited to Trading Account.
However, if it is paid on sales basis then it is debited to Profit and Loss account. If, however, nothing mentioned in an examination problem then it is debited to Trading Account

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