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Expenditure Method: What It Is, How It Works, Formula

The expenditure method is a method for determining GDP that totals consumption, investment, government spending, and net exports.

ECONOMY ECONOMICS

Expenditure Method: What It Is, How It Works, Formula

By ALICIA TUOVILA Updated September 05, 2020

Reviewed by TOBY WALTERS

Fact checked by PATRICE WILLIAMS

What Is the Expenditure Method?

The expenditure method is a system for calculating gross domestic product (GDP) that combines consumption, investment, government spending, and net exports. It is the most common way to estimate GDP. It says everything that the private sector, including consumers and private firms, and government spend within the borders of a particular country, must add up to the total value of all finished goods and services produced over a certain period of time. This method produces nominal GDP, which must then be adjusted for inflation to result in the real GDP.

The expenditure method may be contrasted with the income approach for calculated GDP.

KEY TAKEAWAYS

The expenditure method is the most common way of calculating a country's GDP.

This method adds up consumer spending, investment, government expenditure, and net exports.

Aggregate demand is equivalent to the expenditure equation for GDP in the long-run.

The alternative method to calculate GDP is the income approach.

How the Expenditure Method Works

Expenditure is a reference to spending. In economics, another term for consumer spending is demand. The total spending, or demand, in the economy is known as aggregate demand. This is why the GDP formula is actually the same as the formula for calculating aggregate demand. Because of this, aggregate demand and expenditure GDP must fall or rise in tandem.

However, this similarity isn't technically always present in the real world—especially when looking at GDP over the long run. Short-run aggregate demand only measures total output for a single nominal price level, or the average of current prices across the entire spectrum of goods and services produced in the economy. Aggregate demand only equals GDP in the long run after adjusting for price level.

The expenditure method is the most widely used approach for estimating GDP, which is a measure of the economy's output produced within a country's borders irrespective of who owns the means to production. The GDP under this method is calculated by summing up all of the expenditures made on final goods and services. There are four main aggregate expenditures that go into calculating GDP: consumption by households, investment by businesses, government spending on goods and services, and net exports, which are equal to exports minus imports of goods and services.

The Formula for Expenditure GDP is:

\begin{aligned} &GDP = C + I + G + (X - M)\\ &\textbf{where:}\\ &C = \text{Consumer spending on goods and services}\\ &I = \text{Investor spending on business capital goods}\\ &G = \text{Government spending on public goods and services}\\ &X = \text{exports}\\ &M = \text{imports}\\ \end{aligned}

​ GDP=C+I+G+(X−M) where:

C=Consumer spending on goods and services

I=Investor spending on business capital goods

G=Government spending on public goods and services

X=exports M=imports ​

Main Components of the Expenditure Method

In the United States, the most dominant component in the calculations of GDP under the expenditure method is consumer spending, which accounts for the majority of U.S. GDP. Consumption is typically broken down into purchases of durable goods (such as cars and computers), nondurable goods (such as clothing and food), and services.

The second component is government spending, which represents expenditures by state, local and federal authorities on defense and nondefense goods and services, such as weaponry, health care, and education.

Business investment is one of the most volatile components that goes into calculating GDP. It includes capital expenditures by firms on assets with useful lives of more than one year each, such as real estate, equipment, production facilities, and plants.

The last component included in the expenditure approach is net exports, which represents the effect of foreign trade of goods and service on the economy.

Expenditure Method vs. Income Method

The income approach to measuring gross domestic product is based on the accounting reality that all expenditures in an economy should equal the total income generated by the production of all economic goods and services. It also assumes that there are four major factors of production in an economy and that all revenues must go to one of these four sources. Therefore, by adding all of the sources of income together, a quick estimate can be made of the total productive value of economic activity over a period. Adjustments must then be made for taxes, depreciation, and foreign factor payments.

The major distinction between each approach is its starting point. The expenditure approach begins with the money spent on goods and services. Conversely, the income approach starts with the income earned (wages, rents, interest, profits) from the production of goods and services.

Limitation of GDP Measurements

GDP, which can be calculated using numerous methods, including the expenditure approach, is supposed to measure a country's standard of living and economic health. Critics, such as the Nobel Prize-winning economist Joseph Stiglitz, caution that GDP should not be taken as an all-encompassing indicator of a society's well-being, since it ignores important factors that make people happy.

स्रोत : www.investopedia.com

What Is an Expenditure? Types, Differences and Examples

Learn about expenditures and review the difference between expenditures and expenses, plus explore examples of three different types of expenditures.

What Is an Expenditure? Types, Differences and Examples

Michelle Matthews

Updated December 20, 2022

The founder of RBG Royalty Enterprises, Michelle Matthews is a certified professional career coach and accounts payable professional who helps individuals craft strategic approaches in the workplace using her signature Boss Up & Hustle framework.

Expenditures are a part of everyday business terminology. People use this value to track the cost and payments of products and services they provide. Understanding this key accounting term can help you increase your financial literacy.

In this article, we define what an expenditure is and provide examples of the types of expenditures organizations are likely to encounter.

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What is an expenditure?

An expenditure is a payment of cash or credit for goods or services, often by a business, organization or corporation. The purchase may be to obtain new assets, improve upon or repair assets, or reduce liability. An expenditure is recorded only at the time of purchase, compared to an expense, which is accrued over time.

To record an expenditure, an accountant or bookkeeper shows evidence that the sale occurred. A sales receipt shows proof of an over-the-counter sale, for example, while an invoice shows that there has been a request for payment in exchange for a product or service.

Companies record expenditures accurately to maintain control over finances and limit operating costs to the lowest possible amount. They anticipate profits and losses while monitoring revenue. Without monitoring expenditures, managers would run the risk of potentially overspending and impacting the company's profit margins.

Related: The Value of Increasing Your Business Vocabulary

Expenditures vs. expenses

Though the terms seem similar, it's important to understand the difference between an expense and an expenditure. Here's how they compare:

Expenditures: This term refers to the total purchase price of a good or service. For example, if a company buys a piece of equipment for $30 million and it has a useful life of six years, this is a capital expenditure.

Expenses: This refers to the amount that's recorded for the purpose of offsetting a company's revenue or income. Using that same example, the $30 million piece of equipment with a six-year life has a depreciation expense of $5 million each year.

Read more: Expenditures vs. Expenses: Definitions and Key Differences

Types of expenditures

Expenditures have two broad categories: capital expenditures and revenue expenditures. Organizations use both categories to establish themselves, start operations or expand their business. Below are descriptions of the types of expenditures:

Capital expenditure

A company incurs a capital expenditure when it buys an asset that has a life of more than one year (non-current asset). A building, for example, is a capital expenditure. It could also be a significant expansion or even the acquisition of a new asset that generates substantial revenue for the organization. These investments usually require a substantial upfront investment and continuous maintenance to keep the asset functional, so many companies choose to finance these projects.

Because it's a capital expenditure, the benefits the business has from this investment come over the course of a number of years. This means it can't deduct the full cost of the asset in the financial year that it's purchased. Instead, the deduction is spread over the life of the asset and shown on the balance sheet under non-current assets.

Related: What Is the Income Expenditure Model? (Includes Examples)

Revenue expenditure

This type of expenditure refers to when a company spends money on a short-term benefit (less than one year). Revenue expenditures are often used to fund an organization's ongoing operations, which are known as its operating expenses. The company's income isn't impacted until the expenditure is recorded.

Related: How To Calculate Income Tax Expense

Deferred revenue expenditure

A deferred revenue expenditure, sometimes also noted as a deferred expense, is a payment made in advance for goods or services. The agreement is usually arranged to document that a company receives goods or services in the future, but the payment is made in advance.

The company treats the arrangement like an asset until it receives the benefits. The arrangement doesn't impact the business's profitability because the asset has not been acquired and the benefits of the goods or services haven't been obtained either. The company documents the outcome of the arrangement to the profit or loss account over a noted timeframe.

Read more: Deferred Revenue: Definition and Example

Differences between capital expenditure and revenue expenditure

Capital expenditures are related to long-term spending that involves a major investment. Revenue expenditures are for short-term operating expenses. They're both recorded in the same financial year as they're incurred and aren't allowed to be documented in the next financial year.

स्रोत : www.indeed.com

Classification of Expenditure

Expenditure is classified into 2 types - Revenue and Capital Expenditure. Expenditure is the expend or spending of money on some commodities. To learn more, stay tuned to BYJU'S.

CommerceList of Commerce ArticlesClassification Of Expenditure

Classification of Expenditure

Classification of Expenditure Expenditure definition

Expenditure is referred to as the act of spending time, energy or money on something. In economics, it means money spent on purchasing any goods or services.

There are two categories of expenditures which are:

Revenue Expenditures

Capital Expenditures

Revenue Expenditures

Revenue expenditures are the expenditures incurred for the basis other than the creation of physical or financial assets of the central government. These are associated with the expenses incurred for the normal operations of the government divisions and various services, interest payments on debt sustained by the government, and grants given to state governments and other parties (even though some of the endowments might be meant for the creation of assets).

Budget documents allocate total expenditure into plan and non-plan expenditures. These are shown in item 6 on the table within revenue expenditure, a distinction is made between plan and non-plan. According to this categorisation, a plan revenue expenditure is associated with central plans (the Five-Year Plans), and central aid for state and union territory plans.

Non-plan expenditure, the more significant component of revenue expenditure, covers a broad degree of general, economic, and social services of the government. The main objects of a non-plan expenditure are interest payments, defence services, subsidies, salaries, and pensions.

Capital Expenditures

There are the expenditures of the government that result in the creation of physical or financial assets, or depletion in financial liabilities. This incorporates expenditure on the investment of building, land, equipment, machinery, investment in shares, and loans and advances by the central government to state and union territory governments, Public Sector Undertakings (PSUs), and other parties.

Capital expenditure is also classified as plan and non-plan in the budget documents. A plan capital expenditure, like its revenue equivalent, is associated with central plan and central assistance for state and union territory plans. A non-plan capital expenditure covers different general, social, and economic services furnished by the government.

The Medium-term Fiscal Policy Statement sets a 3-year rolling target for specific fiscal indicators and examines whether revenue expenditure can be financed through revenue receipts on a sustainable basis and how productively capital receipts market borrowings are being consumed.

The Fiscal Policy Strategy Statement sets the preferences of the government in the fiscal sector, examining current policies and justifying any deviation in important fiscal measures. The Macroeconomic Framework Statement assesses the prospects of the economy for the GDP growth rate, the fiscal balance of the central government, and external balance.

Meaning Revenue expenditure refers to the expenditure that neither creates assets nor reduces the liability of the government. Capital expenditure refers to the expenditure that either creates an asset or reduces the liability of the government.

Nature They are regular and recurring. They are irregular and non-recurring.

Term Short-term Long-term

Example Payment of salaries, maintenance of roads, street lights, etc. Repayment of loans, purchase of machinery, etc.

(a) Salary paid to army officers Revenue expenditure

Reason: It neither creates any asset nor reduces the liability of the government.

(b) Loan given to union territories Capital expenditure

Reason: It increases the assets of the government.

(c) Pension paid to retired government employees

Revenue expenditure

Reason: It neither creates an asset nor reduces the liability of the government.

(d) Interest paid on national debt

Revenue expenditure

Reason: It neither creates an asset nor reduces the liability of the government.

(e) Repayment of loan taken from the World Bank Capital expenditure

Reason: It reduces the liability of the government.

Capital expenditure refers to the expenditure that either creates an asset or reduces the liability of the government.

Construction of metros and dams, and repayment of loans to IMF

स्रोत : byjus.com