Chapter 2
Linking Personal Accounting to Business Accounting
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decrease in accounts receivable shows that the service provider received cash and is no longer owed
any amount from the customer (i.e. nothing is “receivable”).
For example, suppose a business provides services valued at
$1,100 and has sent an invoice to the client.The client has prom-
ised to pay in one month. Even though this client is not paying
for the services immediately, equity increases and is recognized as
service revenue on the income statement.This causes net income
to increase. The amount is also recorded in accounts receivable,
an asset indicating the business expects to receive cash from the
client in the future.This is illustrated in Figure 2.11. Remember
that recognizing revenue results in an increase to equity.
Now assume that one month has passed and the business receives
payment of $1,100 from the client. Figure 2.12 illustrates the
accounting impact of this transaction. This transaction is often
referred to as “receipt of account.” Equity does not change since
one asset is exchanged for another.
Recording Expenses
Expenses, similar to revenues, are recorded when they are incurred, not necessarily when they are
paid.This led to three different timings of the cash payments for expenses.
1. Pay before the expense is incurred
2. Pay when the expense is incurred
3. Pay after the expense is incurred
Notice we use the term “incurred” in all three scenarios. An expense is incurred by a company if
the activities related to the expense have been used or consumed. You may also see the term “recog-
nized” when it comes to expenses and revenue.
Recognizing
an expense or revenue simply means
recording the expense or revenue on the income statement. For example, if a company has hired a
lawn care service company to water the grass on its premises on August 16, the expense has been
incurred once the grass has actually been watered. The expense would be recognized at that time.
If a company pays for internet services, the internet expense for a given month has been incurred
once that month has ended (i.e. the internet services for one month have been used up). In all cases,
when an expense is recognized, this means that equity will decrease.
2
ASSETS
BALANCE SHEET
LIABILITIES
OWNER’S EQUITY
CASH
ACCOUNTS
RECEIVABLE
PROPERTY, PLANT
& EQUIPMENT
PREPAID
EXPENSES
OFFICE
SUPPLIES
ACCOUNTS
PAYABLE
UNEARNED
REVENUE
BANK
LOAN
OWNER’S
CAPITAL
OWNER’S
DRAWINGS
+ $1,100
- $1,100
No change in owner’s equity
Receive cash from
customer for
amount owed
______________
FIGURE 2.12
