Why finance charges are non-operating expenses ?

Why finance charges are non-operating expenses ? And is there any thumb rule to identify whether the expense is operating or non-operating.

asked Feb 18, 2017 in General by caankitjain (8 points) 149 views

1 Answer

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Operating expenses are those expenses which are essential to the carrying out the main activities of the business but not including Cost of Goods Sold.   All the normal administrative and sales expenses are operating expenses.  For example salaries, rent, commission, telephone, advertising and travelling expenses are operating expenses.

Non Operating expenses are those expenses which are incurred for non essential activities of the firm.  For example for a firm manufacturing electric bulbs payment of interest is a non operating expense  but for a Finance Firm it is an operating expense because for the former firm raising money is not its main business but for a finance firm raising funds and lending funds is its main business.  Other examples of non operating expenses are cost of obsolescence, cost of currency exchange and payment for a law suit or amount spent on reorganisation of the business.

So to identify whether an expense or income is operating or non-operating is to see what is the main business of the firm.  For example business of a firm A is to manufacture electronic goods, its rival, firm B files a law suit against  firm A for copying its products.  Firm a spends Rs.50,000 on defending this law suit.  Though this expense relates to the business of firm A but it is not related to its main business of manufacturing and selling electronic goods.  So, this is a non-operating expense.  This is the way to judge whether an expense is an operating or non-operating expense.

Let us take another example, the Firm A has spare space which it lets out at a monthly rent of Rs.10,000.  This is not an operating income because Firm A is not in the business of real estate.  So this is a non-operating income.

answered Feb 18, 2017 by jbsclasses (3,971 points)
Thank you sir for the answer. But, my consfusion is still a bit there. Let me try to put my confusion.  

You said that raising money is not the main business of the manufacturing co. But sir, the money raised is used in the business of manufacturing only.Ultimately, interest is paid for financing the operations of the business.

If i accept your point, then rent paid for business premises should also be non-operating, since our main business is not getting property on rent.

Request you to ellaborate.

In case of any doubt, please don't hesitate to discuss furthr.

 

Thank you sir for the answer. I got your point.

Basically our purpose is to measure the operational effecieny of the main business of the entity.

Interest paid or not is a part of financial effeciency.

Thanks once again.
Use of debt to enhance the profit of equity shareholders is called leverage. The objective of a firm is to use enhance the profitability of equity shareholders.  In doing so they have to strike a balance between use of debt and increase in risk.  This is the reason why interest payment is considered a non-operational activity.
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