Chapter 2
Linking Personal Accounting to Business Accounting
38
Pay Cash when the Expense is Incurred
When a company incurs an expense and pays
for it immediately, the transaction is fairly
straightforward.Fromthe company’s perspec-
tive, cash decreases and equity decreases.The
decrease in equity is recorded as an expense
on the income statement, which reduces net
income. Suppose a business paid $800 cash
for the cost to travel to a client’s head office.
Figure 2.14 illustrates the accounting treat-
ment when paying immediately in cash for
travel expenses. Remember that recognizing
an expense results in a decrease to equity.
Pay Cash after the Expense is
Incurred
Many expenses are paid after they have been
incurred. This form of paying expenses is
sometimes referred to as “paying on account.” You may mistakenly think that the value of equity
would not change until the expense is paid for. However, accounting standards require expenses to
be recorded at the time they are incurred, regardless of when the payment is made.
A business that provides products or services to another business is known as a supplier. When a
company owes a supplier for a product or service, the money owed is recorded as a liability called
accounts payable. When an invoice is issued to the company by the supplier (after the expense has
been incurred), the value of the invoice is treated as an increase to the accounts payable account and
an increase to the appropriate expense account.
Later, when the company actually pays the
outstanding amount, the transaction is a
decrease to cash and a decrease to accounts
payable.The company used cash to pay and it
no longer owes any amount to the supplier
(i.e. nothing is “payable”).
Suppose a business will pay for a maintenance
expense two months after it has been incurred.
Even though the business is not paying for
the services immediately, the supplier will
issue an invoice as soon as the maintenance
work is done. Assume that the supplier is
charging $700 for its maintenance services.
Figure 2.15 shows the impact on the applicable
INCOME STATEMENT
NET INCOME (LOSS)
EXPENSES
2
ASSETS
BALANCE SHEET
LIABILITIES
CASH
ACCOUNTS
RECEIVABLE
PROPERTY, PLANT
& EQUIPMENT
PREPAID
EXPENSES
OFFICE
SUPPLIES
ACCOUNTS
PAYABLE
UNEARNED
REVENUE
BANK
LOAN
- $800
SERVICE REVENUE
DEPRECIATION
INTEREST
INSURANCE
SALARIES
RENT
TELEPHONE
TRAVEL
MAINTENANCE
Owner’s equity decreases by $800
OWNER’S EQUITY
OWNER’S
CAPITAL
OWNER’S
DRAWINGS
+ $800
______________
FIGURE 2.14
INCOME STATEMENT
NET INCOME (LOSS)
EXPENSES
2
ASSETS
BALANCE SHEET
LIABILITIES
CASH
ACCOUNTS
RECEIVABLE
PROPERTY, PLANT
& EQUIPMENT
PREPAID
EXPENSES
OFFICE
SUPPLIES
ACCOUNTS
PAYABLE
UNEARNED
REVENUE
BANK
LOAN
+ $700
SERVICE REVENUE
DEPRECIATION
INTEREST
INSURANCE
SALARIES
RENT
TELEPHONE
TRAVEL
MAINTENANCE
Owner’s equity decreases by $700
OWNER’S EQUITY
OWNER’S
CAPITAL
OWNER’S
DRAWINGS
+ $700
______________
FIGURE 2.15
