Explanation and Treatment of Direct Expenses

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on October 8, 2021

All direct expenses are recorded on the debit side of the Trading Account. This article provides a detailed explanation of various direct expenses.

Opening Stock or Opening Inventory

In a trading business, opening stock consists of different types of finished goods. By contrast, in a manufacturing business, opening stock consists of raw materials, work-in-progress, and finished goods.

Unsold closing stock from 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 because 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. It is recorded on top of the debit side of Trading Account.

Purchases

This direct expense is the balance of the 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 the Trading Account. If there are any purchase returns in the Trial Balance, these must be deducted from the purchases. Only net purchases should be recorded on the debit side of the Trading Account.

Carriage Inward

or Carriage In or Carriage Inwards or Carriage on Purchases or Transportation Inwards

Carriage inward is also known as carriage, carriage on purchases, or transportation inward. Carriage inward refers to the expenses incurred to bring the purchased raw materials or goods to the factory, godown, shop, or workplace.

Generally, the term “carriage” is used to refer to the expenses paid to transport goods from one city to another city within the same country. These expenses are recorded on the debit side of the Trading Account.

Students should remember that carriage paid on goods sold is called carriage outward. It is not a direct expense and should not be recorded in Trading Account; rather, it is recorded in the Profit and Loss Account.

Cartage

Cartage is another term used to refer to the expenses incurred to bring the purchased goods to the factory, godown, shop, or workplace.

Generally, the term “carriage” is used for the expenses paid to move goods from one place to another within the same city. These expenses are recorded on the debit side of the Trading Account.

Students should remember that carriage paid on goods sold is not a direct expense and should not be recorded in the Trading Account; instead, it is recorded in the Profit and Loss Account.

Freight or Freight Inward

These expenses are paid as a fare to the ship or aircraft operator that transports goods purchased from abroad. Given that these expenses are connected with the purchase of goods, they are recorded on the debit side of the Trading Account.

Insurance in Transit

These are the charges paid to the insurance company to cover losses that may occur during the transit of goods purchased.

Since these expenses are incurred in connection with the purchase of goods, they are considered direct and are recorded on the debit side of the Trading Account.

Packing Charges

Certain types of goods cannot be sold without packing. In such cases, the packing becomes part of the product and is treated as a direct expense. For example, ink cannot be sold without a bottle or sachet.

These types of packing charges are debited to the Trading Account. However, other types of packing that are not direct expenses (e.g., safety-promoting packing such as carton packing for medicine) are debited to the Profit and Loss Account.

Landing and Wharf Charges or Dock Charges

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

Clearing Charges

Some imported goods must be cleared at ports and airports. Any 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 Customs Duty

The government imposes different taxes on the import of goods from abroad, each with different names (e.g., import duty, customs duty, and excise duty). #

When these taxes are paid on bought goods, they are considered direct expenses and are debited to the 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 a direct expense and debited to the Trading Account.

Wages and Salaries

In trading concerns, wages are the remuneration paid to the workers for loading and unloading the goods, as well as other tasks.

If these wages are paid in connection with the goods bought, then these are treated as direct expenses and debited to the 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, manufacturing wages, and factory wages.

Productive wages are treated as direct expenses and should be debited to the Trading Account.

Factory Rent, Factory Expenses, Factory Insurance, Factory Rates, and Factory Lighting and Heating

All expenses incurred in the process of manufacturing goods, including factory rent, factory insurance, and factory lighting and heating, are called manufacturing expenses.

Given that all these expenses are related to the production of goods, they are considered direct expenses and are debited to the Trading Account.

Motive Power

Motive power expenses include the fuel, gas, water, and other energy incurred to run the machines used for production. They are considered direct expenses because they are directly related to the production of goods, and they are debited to the Trading Account.

Students should remember that the electricity used in the administrative and sales departments should be debited to the Profit and Loss Account.

Consumable Stores

Consumable stores such as lubricating oils (engine oils), grease, and cotton waste are used to keep machinery in proper working condition.

As this machinery is used in the production of goods, the value of any consumable stores that are consumed is treated as a direct expense and debited to the Trading Account.

Raw Materials

Some raw materials are directly used in the production of goods, such as tallow used in the fabrication 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, the expenses incurred on them are considered direct expenses and are debited to the Trading Account.

Royalty

Royalty is essentially a form of rent that is paid to use certain rights. A manufacturer or producer pays a royalty to receive the rights to produce certain articles that belong to others.

For example, a publisher pays a royalty to the author of a book to get the rights to publish it.

Similarly, a company may pay a royalty to their landlord to secure the right to drill for oil and gas in a particular area. As another example, manufacturers pay royalties to patent-holders to use their intellectual property.

Royalties may be paid on a production basis or on a sales basis. If paid on a production basis, then the royalty is considered a direct expense and debited to the Trading Account.

However, if the royalty is paid on a sales basis, then it is debited to the Profit and Loss account. If, however, nothing is specific in an exam question, then you should debit the royalty to the Trading Account.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.

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