Financial Accounting · The main elements of financial statements

Income and Expenses Definitions in ACCA Financial Accounting

Updated 11 October 2026 · Fact-checked

Under the IASB Conceptual Framework, income is an increase in assets or a decrease in liabilities that increases equity, other than contributions from equity holders. Expenses are decreases in assets or increases in liabilities that decrease equity, other than distributions to equity holders. To solve questions, check the effect on equity.

Understand Income and Expenses Definitions

Start with the accounting equation: assets − liabilities = equity. Profit changes equity. So the Conceptual Framework defines income and expenses by their effect on assets and liabilities, not by cash.

Income is an increase in assets, or a decrease in liabilities, that results in an increase in equity. The exception is contributions from holders of equity claims. If owners pay in share capital, assets rise and equity rises, but this is not income.

Expenses are decreases in assets, or increases in liabilities, that result in a decrease in equity. The exception is distributions to holders of equity claims. A dividend reduces assets and equity, but it is not an expense. It goes in the statement of changes in equity.

Income includes both revenue and gains. Revenue arises in the course of ordinary activities, such as sales. Gains arise from other items, such as a profit on disposal of a non-current asset. Expenses include both expenses from ordinary activities (cost of sales, wages, depreciation) and losses (such as a loss on disposal or a fire loss). Gains and losses are usually shown net or separately, depending on how they arise.

Timing follows the same logic. You recognise income when an increase in assets or decrease in liabilities can be measured reliably enough and is relevant, and you recognise an expense when an asset falls or a liability rises. This is why accruals, prepayments and depreciation matter. Cash timing does not decide the profit.

Key formulas to remember

Income: Income = increase in assets or decrease in liabilities that increases equity (excluding contributions from equity holders); Includes revenue and gains.
Expenses: Expenses = decrease in assets or increase in liabilities that decreases equity (excluding distributions to equity holders); Includes ordinary expenses and losses.
Profit: Profit = income − expenses; Profit for the period increases equity (if positive).
Equity link: Closing equity = opening equity + profit + capital introduced − dividends (± other comprehensive income); Capital and dividends bypass profit or loss.

How to solve Income and Expenses Definitions questions

Use this method for any question asking whether an item is income, an expense, or neither.

1Identify what happens to assets and liabilities: does an asset rise or fall, or a liability rise or fall?
2Check the effect on equity. If equity does not change, it is not income or an expense.
3Ask whether the other party is an owner acting as an owner (share issue, dividend, drawings). If yes, it is excluded.
4If it is income, decide whether it is revenue (ordinary activities) or a gain.
5If it is an expense, decide whether it is an ordinary expense or a loss.
6Check timing: match to the period when the asset or liability changed, not when cash moved.
7Place the item correctly: profit or loss, or statement of changes in equity.

Quickest way: Equity test

When to use it: Use it for multiple choice questions that list several transactions and ask which is income or an expense.

Ask: does this change profit-type equity, and is the other party an owner?
Equity up, not from owners: income.
Equity down, not to owners: expense.
Equity unchanged (e.g. buying an asset with cash, paying a payable): neither.
Look out for dividends, drawings and share issues: always excluded.

Common mistakes in Income and Expenses Definitions

Treating a dividend paid as an expense.
Cash leaves the business, so it feels like a cost.
Fix: Dividends are distributions to equity holders. They are excluded from expenses and shown in the statement of changes in equity.
Treating share capital received as income.
Assets rise, so it looks like income.
Fix: Contributions from equity holders are excluded from income. Only increases in equity from other sources count.
Treating cash paid as an expense.
Students think in cash terms.
Fix: Buying equipment swaps one asset for another. No expense arises until depreciation reduces the asset.
Confusing revenue with income.
The two words sound the same.
Fix: Income is the wider term. It includes revenue plus gains such as profit on disposal.
Treating repaying a loan as an expense.
Cash falls.
Fix: Repaying principal reduces an asset and a liability equally. Only interest is an expense.
Recognising income when cash is received in advance.
Cash received feels like earned money.
Fix: Cash in advance creates a liability (deferred income). Income is recognised when it is earned.

Worked examples

Example 1

Which ONE of the following is an expense under the Conceptual Framework definition? A) Dividend of $10,000 paid to shareholders B) Purchase of a machine for $50,000 in cash C) Wages of $8,000 paid D) Repayment of a $20,000 loan

Show the solution

A: assets fall and equity falls, but this is a distribution to equity holders. Excluded.
B: one asset (cash) is exchanged for another (machine). Equity is unchanged.
C: cash falls by $8,000 and equity falls. The other party is not an owner. This is an expense.
D: cash and a liability fall equally. Equity is unchanged.

Answer: C: wages of $8,000 paid.

Example 2

A business starts the year with assets of $200,000 and liabilities of $80,000. During the year it issues shares for $30,000, pays dividends of $12,000 and earns a profit of $45,000. Calculate closing equity.

Show the solution

Opening equity = 200,000 − 80,000 = $120,000.
Add share issue: this is a contribution from owners, not income. 120,000 + 30,000 = 150,000.
Add profit: 150,000 + 45,000 = 195,000.
Deduct dividends: this is a distribution, not an expense. 195,000 − 12,000 = 183,000.

Answer: Closing equity is $183,000. Only the $45,000 profit passes through profit or loss.

Exam tips

In multiple choice questions, apply the equity test to each option and cross out those that leave equity unchanged.
Watch for the words dividend, drawings and share issue. They signal items excluded from income and expenses.
Know the difference between income (revenue plus gains) and expenses (ordinary expenses plus losses). Questions may test the definitions word for word.
In multiple response questions, select exactly the number asked and check each option separately.
For number entry, show equity movements step by step on scrap paper before keying the answer.

Practice questions from The main elements of financial statements

Income and Expenses Definitions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Income and Expenses Definitions: frequently asked questions

What is the difference between income and gains?

Income is the wider category. It includes revenue, which arises from ordinary activities, and gains, which arise from other events such as a profit on disposal of a non-current asset.

What is the difference between expenses and losses?

Expenses is the wider category. It covers costs of ordinary activities such as wages and depreciation, and also losses, such as a loss on disposal or damage from a fire.

How does income affect equity?

Income increases equity because it raises assets or reduces liabilities. Expenses decrease equity. Profit, which is income less expenses, is added to equity at the end of the period.

Is a dividend an expense?

No. A dividend is a distribution to equity holders. It reduces equity directly and appears in the statement of changes in equity, not in profit or loss.