Let’s call a spade, a spade! Unfortunately not so simple in the world of accounting. Whether you are a sole trader or limited company, there are a number of different ways in which purchases of equipment and tools can be categorised in your accounts. If you are doing your own books it can be tricky to work out these purchases should go.
Deciding on the category depends less on what the item is and more on the size and nature of your business. There are three main headings:
1. Cost of Sales (Purchases, Materials)
I like to think of cost of sales as items that end up with the customer or are used up in the process of creating something for the customer. You might also see this category called Purchases and, or Materials. Some examples of cost of sales for different trades:
Builder – cost of sales would be the building materials but not tools.
Supermarket – cost of sales would be the food and other items purchased for resale
Hairdresser – cost of sales would be things like the shampoos, hair dyes, foils etc
Web Designer – cost of sales would be stock photos bought for a specific job but not general software subscriptions or licenses.
2. Revenue Expenditure (Expenses)
Expense items are different from cost of sales in that they don’t relate specifically to the customer job. Instead they are part of the general business overheads. There are a couple of categories that they might generally fall into.
Equipment Expensed (Consumables)
These are items of equipment that are either going to be used within the business year across a number of customer jobs or for admin or office purposes. They are generally lower in value (we tend to use a benchmark of £100) and not expected to last more than a year or so.
Builder – equipment expensed would be small tools. It can be a fine line between cost of sales and equipment expensed categories for these types of items in this type of trade. In general, if they might last across a few different jobs then I categorise as equipment expensed; so this would be a hammer but not the nails.
Supermarket – equipment expensed might be pricing machine, coffee machine in staff room
Hairdresser – equipment expensed would be scissors, hairdryer
Web Designer – equipment expensed would be items such as computer mouse, laptop case.
Repairs and maintenance
It can be very difficult to distinguish between equipment expensed and repairs and maintenance and both often involve small tools. For example, small tools and other equipment might be purchased to carry out a repair or maintenance job on the business premises. Here I would use a similar principle of cost of sales: if the item will be used up in the course of the work then categorise as repairs and maintenance, if it will be useful for this job and for future repair work then categorise as equipment expensed.
Builder – repairs to large tools
Web Designer – repairs to computer
Supermarket – repairs to premises, repairs to equipment
Hairdresser – repairs to premises, repairs to equipment
3. Capital Equipment (Assets)
These are higher value items, known as assets, that will be used by the business over a number of years. See the article on capital allowances for more information. We use a rough and ready guideline for small businesses, defining an asset as an items of equipment costing over £100 with a working lifespan of more than 3 years. However there is no firm categorisation, it will depend on the size of your business; for a large business even £1,000 spend may not be considered an asset. The main things to remember are bigger spend and longer lifespan. Examples across all trades include vehicles, computers and large/expensive tools.
One thing to bear in mind is that although an individual item of equipment might not be considered an asset, if you are buying a lot at once then they could be considered together. For example, a hairdresser sets up in business and purchases ten hairdryers and ten pairs of scissors at the same time to get the business up and running. Individually, if bought one at a time, these are not assets but all bought together at the same time they could be treated as an asset. This is useful to bear in mind for capital allowances (see article).
Why is the category important?
Getting cost of sales and expenses right is not so vital. It will affect the accuracy of your accounts but won’t have any affect on the amount of tax you owe. Your overall taxable profit will be the same. Getting capital (assets) right is more important as this does have a direct effect on profit, capital allowances and therefore tax.
Cost of sales – sold to the customer or used up with the customer in your product or service
Expenses – used generally within the business not with a specific customer, low cost and short lifespan
Assets – used generally within the business not with a specific customer, higher cost and longer lifespan
Picture credit – anemoneprojector