Expenses in General
Expenses are the costs incurred to provide goods and services.
Some examples are: Distribution Expenses, Marketing Costs, Research Costs, Administrative Expenses, Bank Charges, Amortisation of intangibles
Along with a company's income, expenses are central in the Income Statement (sometimes referred to as the Profit and Loss statement).
The basic equation underlying the Income Statement is
Revenue + Other Income - Expenses = Income - Expenses = Net Income
Expenses in Fund Accounting
A fund's expenses are the costs incurred in operating a fund and may differ from those of a large corporation, however most of them are broadly similar.
Some examples are: Bank Charges, Auditor's Fees, Broker's Fees. Registration Expenses, Administration Fees
Accrual Accounting requires that revenue be recorded when earned and that expenses be recorded when incurred, irrespective of when the related cash movements occur.
When cash movement and accounting recognition do not occur at the same time, 2 types of expenses arise:
Prepaid expense. It arises when a company makes a payment prior to recognising an expense.
Accrued expense. It arises when a company incurs expenses that have not yet been paid. Accrued expenses are liabilities and are paid in arrears, after the period they relate.
How NAV is affected
Expenses are accounted for on an accrual basis and are recognised during the period to which they relate, not when cash is paid.
NAV equals the Net Assets of the company and is affected when the fund recognises expenses, not when the cash is paid.
This can be easily demonstrated with the 2 types of expenses described above:
Prepaid expense. Cash payment is firstly recorded along with the prepaid expense that is treated as an asset reflecting future benefits, leaving the NAV unaffected. A subsequent adjusting entry records the expense and eliminates the prepaid asset, thereby reducing the NAV.
Accrued expense. When the expense is recognised, the Payable Expense is treated as a Liability, which reduces the NAV. When the cash is paid, cash is reduced under the Assets and Expenses Payable are reduced under the Liabilities, which leaves the NAV unaffected.