What is the Functional Expense Classification?

The functional expense classification is a sorting and presentation method used in accounting, under which expenses are aggregated and reported by the activities for which they were incurred. For example, expenses could be aggregated by department and then reported as (for example) administrative expenses and selling expenses. This approach is most commonly used by larger businesses, which are likely organized into many departments. An income statement that uses the functional expense classification appears in the following exhibit.

What is the Natural Expense Classification?

Under the natural expense classification, expenses are aggregated and reported by their type. Examples are benefits expense, compensation expense, and depreciation expense. This reporting approach is most commonly followed by smaller businesses, which do not have separate departments into which expenses can be sorted.