What is an expense? An expense is the cost of asset consumed or the cost of service used in the process of earning revenue. It is a component of profit or loss that decreases owner’s equity. In business, expenses arise from operating the company.
This post is part of the “how to debit and credit” tutorials that describe how to record accounting transactions. In this basic accounting level, we use the transactions of Frontier Advertising Company (FAC). For simplicity, we assume that FAC uses accounting period of one month. Three levels of transaction analysis will be adopted (that is, the basic analysis, analysis using accounting equation, and debit-credit analysis). According to those analyses, you will easily understand how transactions are recorded in the general journal.
Index of how to debit and credit tutorial
Why does a company incur expenses?
A company incurs expenses as it consumes economic resources in the process of earning revenue. For example, the office used by an advertising company requires the use of electricity, services performed by employees, and office supplies. In accounting, expenses are recognized and recorded to reflect the cost of such resources that has been consumed or used up. On the other hand, the cost of resources that still has future benefits is recorded as assets.
How to debit and credit payment of rent expenses?
On January 3, FAC pays office rent for January in cash, $900. The occupational rent payments are agreed to be made monthly.
Basic transaction analysis
The asset of FAC in the form of $900 cash is no longer held by the FAC. On the other hand, the equity component, Rent Expense, arises. The payment is recognized as an expense since it only pertains to the current accounting period (the month of January).
Accounting equation analysis
Accounting equation can be used to show the economic effects of an accounting transaction. It states that the total value of a company's assets must always equal the combined value of its liabilities and its owners' equity.
In this illustration, the effects of the cash receipt and the incurring of liability can be shown in terms of the accounting equation as follows:
The amount of $900 is in parentheses. It is the conventional accounting notation to show subtracting effect or minus sign.
According to the debit-credit rule, the decrease in assets is credited. The payment in cash means that the cash paid is no longer held by the company. Technically, the Cash account is credited $900.
The debit-credit rule also requires the incurring of expenses to be debited in expense account. Since the rent payment is related to the month of January, the same accounting period, we treat the payment as being consumed by FAC. From the accounting point of view, the Rent Expense account is debited $900.
In a manual accounting system, the journal entry is recorded in a general journal book. The general journal is made of pages with several columns for date, account title, account code, reference, and debit and credit amounts. Regularly, a batch of debit and credit amounts in the journal entries are posted to the relevant accounts in the general ledger.