Summary: Expense reimbursement means paying back employees for expenses incurred on behalf of the company when carrying out their duties.
Imagine you’re an employee sent to a trade fair to represent your employer. When you set up your booth, however, you quickly realize that one of the lights you use to illuminate your products isn’t working properly. Luckily, you’re early and you have time to run out to a store and pick up a new one, though of course, you have to pay for it.
Keep that receipt! You’ll need it to claim back the money you paid on your employer’s behalf.
This is one simple example of how expense reimbursement works and in the rest of this article, we’ll discuss how important it is to both employers and employees to have an effective reimbursement system in place.
What Is Expense Reimbursement?
Expense reimbursement is the practice and process of paying employees back for work-related costs they paid out of pocket. This can include expenses that employees regularly incur as well as one-offs like the light in our example above.
While the nature of some jobs means that expenses are expected, employers should have systems in place for anyone to be properly reimbursed if necessary.
What Kinds of Expenses Are Reimbursed by Employers?
There are lots of different types of expenses that employers reimburse their employees for. However, they all share some specific qualities in common.
First, all of these expenses are costs that the employee incurred and paid for with their own funds. Second, they’re all expenses that the employee incurred while working or doing activities related to their jobs.
Finally, these are generally expenses that the employee can prove accurately with paid invoices or receipts, though some employers allow small reimbursements without them. Different employers have different policies on what’s reimbursable and what’s not, and these will vary from company to company.
It’s very important for employees to know the types of expenses they can be reimbursed for so that they don’t spend out-of-pocket on things they mistakenly believe will be repaid.
Some common types of expenses that are frequently reimbursed include:
- Travel expenses: When employees travel for work, they may need to pay for things like taxis, flights, and accommodation first. If they use their own vehicles for work-related purposes, they may be reimbursed for their fuel usage and repaid for the mileage driven with their personal vehicle.
- Meal expenses: Many employers provide a daily stipend for meals while employees are traveling and refund their expense accounts. Business meals or coffee meetings with clients are also normally reimbursable.
- Promotion expenses: Anyone promoting the company may be reimbursed for the advertising costs, branding, events, sponsorships, and gifts they pay for with their own funds.
- Material expenses: In many offices, workers are encouraged to buy the supplies and equipment they need and are refunded. Remote staff are often given budgets to set up their offices and utilities, and then reimbursed later.
- Education and training expenses: Staff sent on training courses can incur out-of-pocket expenses. Some employees even take college-level courses and full degrees and their tuition is reimbursed by their employers.
Expense Reimbursement Process
How does expense reimbursement work? Each employer can create their own workflow for reimbursements to take into account the needs of their accounting departments and the payroll and banking systems it use.
However, most expense reimbursement processes follow this basic outline:
- Step 1: The employee pays out of pocket for a business expense considered reimbursable by the employer.
- Step 2: The employee obtains a receipt for this spending or otherwise documents it.
- Step 3: The employee submits an expense report with documentation to the employer. This could be on a regular schedule or sporadic, depending on need.
- Step 4: The employer reviews the expense report and pays the employee back, either directly for rare expenses or every pay period for regular expenses.
This process can take time, especially when employees are traveling for work and need to return to the office to settle their expense reports.
However, technologies like employee management platforms offer employee portals that often let them submit their expenses remotely.
Pros and Cons of Expense Reimbursement
Some US states require companies to have expense reimbursement systems in place. In other jurisdictions, companies get to decide for themselves whether or not to use such a system based on a comparison of the related advantages and disadvantages one would produce.
Advantages of Expense Reimbursement
Encouraging employees to pay for expenses out of pocket and then be reimbursed can produce the following advantages:
- Flexibility and responsiveness: Letting employees pay for unexpected expenses quickly and be reimbursed later helps companies access funds when needed.
- Good employee relations: With a clear policy in place, employees know what they can pay and be reimbursed for later. Showing employees that they’re trusted to make appropriate financial decisions can help to build confidence and enhance morale.
- Clear accounting: An expense reimbursement system with documentation required helps businesses manage their expenses and keep their accounts clearly in order.
- Accountability: Giving employees company credit cards or cash allowances can lead to less responsible spending. In comparison, a clear reimbursement policy lets employees know that they need to have documentation and justification for their spending to get their own money back, leading them to be more accountable.
Disadvantages of Expense Reimbursement
While the advantages of expense reimbursement systems are clear, they also come with downsides that include:
- More complicated accounting: Introducing a system in which there are many more sources of spending to monitor, and which requires repayments to many people, creates more work for an accounting department.
- Employee financial issues: Expecting employees to pay for significant expenses and then paying them back at a later date can interfere with their cash flow and introduce financial stress into their lives.
- Room for error: With many people effectively spending company money, there is more room for mistakes in calculations, deciding what’s reimbursable, and repayment. If such errors happen frequently, it can cause employees to lose money or resent a system that benefits the employer but can punish them.
How to Create an Effective Expense Reimbursement Policy
Employers are generally free to create their own expense reimbursement systems and these are normally grounded in clear and robust policies. When creating a policy, an employer has to consider many different factors and variables, which include:
Defining “reimbursable”: The employer needs to have a clear idea of the sorts of expenses that employees may incur and create clear rules for defining what does and does not qualify as reimbursable. These categories need to be made explicitly clear to prevent confusion and animosity when expenses aren’t approved.
Deciding on a documentation process: Employers have to set clear outlines for what they consider appropriate documentation and possibly a spending limit above which documentation isn’t required. If receipts aren’t available or even are misplaced, the employer should indicate what other means of proof (bank or credit card statements, app transaction records, etc.) can be submitted instead.
The employer, working with their accounting department, should also detail how expense reports need to be filed and create the forms or file transfer protocols to be used when submitting them.
Choosing a reimbursement mechanism: Deciding how and when employees can be reimbursed is a critical step. Employers must also consider the types of expenses they commonly reimburse and how large these costs can be. Larger expenses should be processed quickly because it’s not fair to employees to be out of pocket for these big amounts for long periods.
In contrast, small expenses may be tallied up and reimbursed regularly but less frequently. The employer can set rules on how often reimbursements happen, and often that means reimbursing them with employee paychecks.
Sharing policies with employees: Once policies are in place, all affected employees should be made aware of them so they know what can be reimbursed and what can’t. It’s a good idea to train everyone on submitting expense reports to reduce the number of errors when they submit them for real.
Expense Reimbursement and Taxes
Keeping careful track of spending and reimbursements isn’t just going to make accountants happy. Employers can also write off a lot of spending on reimbursements if they’re properly recorded and accounted for. The Internal Revenue Service (IRS) provides guides for employers on what types of business expenses are deductible, including things like employee meals and education fees.
For employees, reimbursements also need to be carefully tracked so that the money paid back to them isn’t incorrectly classified as taxable income.
Expense Reimbursement Summarized
Employers can benefit by having employees pay out of pocket for some spending and then reimbursing them later. While this can create more work for accountants, it creates more flexibility for employers while building trust and financial accountability for employees.
FAQ
This is bound to happen, and that’s why the company needs to set a clear policy in this case that includes alternative documentation, such as transfers or account statements.
With reimbursement, employees use their own money and are paid back later. With an expense account, however, they gain access to the company’s money to use for their expenses, so they’re never out of pocket.