What is Natural Expense Classification?

Natural expense classification refers to the reporting of expenses by the nature of each type of expense. An example of natural expense classification is to report expenses in the following manner:

A presentation of an income statement that uses the natural expense classification appears in the following exhibit.

Reporting Expenses by Function

The natural expense reporting treatment varies from the alternative of reporting expenses by function, such as:

Accounting department expense
Engineering department expense
Marketing department expense
Selling department expense

Who Uses the Natural Expense Classification

The natural expense classification is more likely to be used in smaller companies that do not have formal departmental reporting structures. This approach would not work well for a larger, more complex organization, since the listing expenses on its income statement might run on for several pages. Also, these organizations tightly assign responsibility for all expenses incurred, and the natural expense reporting structure does not provide for reporting by responsible person. Consequently, managers would have a difficult time determining which line items relate to their areas of responsibility.