Expense: Debit or Credit?

Expenses are the monetary charges that a company incurs from the day-to-day operation of its business. Companies break down their expenses and revenues in their income statements during bookkeeping and when it comes to accounting, debits and credits are the two key elements. Based on the double entry system in accounting, an expense is reported as a debit and not a credit.

Understanding debits and credit by exploring their definitions and how they help form the basics of double-entry accounting will help us understand why an expense is a debit entry and not a credit entry. In this article, we will discuss credit and debit and why an expense is recorded as a debit and not a credit.

See also: Liabilities vs assets differences and similarities

The business transactions that are carried out in a company have a monetary impact on the financial statements of a company. Therefore, when it comes to bookkeeping, one always has to be sure that their entries are correct and accurate as this will go a long way in helping them make sure they enter the correct data each and every time a transaction is completed in the business.

Debits and credits are used within a business’s chart of accounts as a way to record every transaction. When a transaction is recorded, every debit entry has to have a credit entry that corresponds with it while equaling the exact amount. This means that, for accounting purposes, every transaction has to be exchanged for something else that has the exact same value. Therefore, the debit total and credits total for any transaction must always equal each other so that an accounting transaction is considered to be in balance. If a transaction were not in balance, it would be difficult to create financial statements.

The term ‘debits and credits’ is frequently used by bookkeepers and accountants when recording transactions in accounting records. In every transaction, an amount must be entered in one account as a credit (right side of the account) and in another account as a debit (left side of the account). This accounting system is referred to as a double-entry system. In accounting records and financial statements, this double-entry system helps to provide accuracy.

Double-entry accounting

The debits and credits are entries in double-entry bookkeeping made in account ledgers to record changes in value resulting from business transactions. A credit entry is designed to always add a negative number to the journal while a debit entry is made to add a positive number. Though in the actual journal entries, you won’t see pluses and minuses written, so it’s important that one gets familiar with the left-side and right-side formats. A debit will always be positioned on the left side of the account whereas a credit will always be positioned on the right side of the account.

The use of credits and debits in the two-column transaction recording format happens to be the most essential of all controls over accounting accuracy. A debit entry in an account would basically signify a transfer of value to that account, whereas a credit entry would signify a transfer from the account. Each transaction in business transfers value from credited accounts to debited accounts.

Take, for instance, you write a rent cheque to your landlord. You would enter a credit for the bank account on which the cheque is drawn and then enter a debit in a rent expense account. Likewise, your landlord would enter a credit in the rent income account associated with the tenant and then enter a debit for the bank account where the cheque is deposited.

Also, when a company borrows money from a bank, the transaction will affect the company’s Cash account and the company’s Notes Payable account. The same thing happens when the company repays the bank loan, as the Cash account and the Notes Payable account are also affected.

Now, if a company buys supplies for cash, the company’s Cash account and its Supplies account will be affected. If the company buys the supplies on credit, the Supplies account and Accounts Payable will both be involved. Furthermore, if the company pays the rent for the current month, the company’s Cash account and Rent Expense are involved.

If a company renders a service and gives the customer/client 30 days to pay, the company’s Accounts Receivable and Service Revenues accounts are both affected. For each transaction mentioned, one account will be credited and one will be debited for the transaction to be in balance. As seen from the illustrations given, for every transaction, two accounts are at least affected. This is why this accounting system is known as a double-entry system.

However, even though the accounting system is referred to as double-entry, a transaction may involve more than two accounts. A company’s loan payment to its bank is a typical example of a transaction that involves three accounts. This transaction will involve the Cash accounts, Notes Payable accounts, and Interest Expense accounts.

Therefore, in double-entry accounting, debits and credits are used to record transactions in a company’s chart of accounts that classify expenses and income. During, double-entry accounting, the challenge however may be to understand which account will have the debit entry and which will have the credit entry.

The table below shows the 5 major accounts in a company’s Charts of Accounts (COA) in which the debits and credits will be entered or recorded. ‘Expense account‘ which is our focus point has been highlighted in the table below:

See also: Assets, Liabilities, Equity: Comparison

In a company, one of the major roles of the company management teams is to maximize profits which is achieved by boosting revenues while keeping expenses in check. Cutting down costs and expenses can help companies make more money from sales. Nevertheless, if expenses are cut down too much it could also have a detrimental effect. For instance, paying less on advertising in order to reduce costs can also lower the company’s visibility and ability to reach out to potential customers.

It is important to note that even though costs and expenses may seem identical in a general lexicon, there is an important difference between them when it comes to accounting. Costs are the finances put forward in order to purchase an asset while the cost incurred in the use and consumption of these assets are expenses.

For example, the money a company spends on purchasing a van is ‘cost’ whereas the cost of buying petrol and servicing the van are expenses. Therefore, all expenses can be considered as costs, but not all costs are necessary expenses.

Companies break down their expenses and revenues in their income statements. The total revenue that the company makes minus its expenses determines the net profit of the company. Expenses are recorded through one of two accounting methods- cash basis or accrual basis accounting. For cash basis accounting, expenses are recorded only when they are paid. Whereas, in the accrual accounting method, expenses are recorded only when they are incurred.

There are two main types of expenses in business such as operating and nonoperating expenses. Operating expenses are the expenses that relate to the main activities of the company. They are the expenses that are incurred from the normal day-to-day running of the company’s business such as the cost of goods sold, direct labor, administrative fees, office supplies and rent.

Non-operating expenses, on the other hand, are expenses that are not directly related to the core operations of the business. They are expenses incurred outside of a company’s day-to-day activities. These are expenses such as interest charges and other costs associated with borrowing money. Non-operating expenses may occur from reorganizing, restructuring, interest charges on debt, or on obsolete inventory. Non-operating expenses and operating expenses are separated from an accounting perspective for the company to be able to determine how much it earns from its core activities.

Expense Account

An expense account records all the decreases in the owners’ equity that occur from the use of assets or increasing liabilities in delivering goods or services to a customer. It takes account of the costs of doing business, that is, all expenses incurred by a business during an accounting period such as expense accounts for bad debts, water, telephone, fuel, salaries, electricity, repairs, wages, depreciation, interest, stationery, entertainment, honorarium, rent, utility, etc.

The expenses account helps the company oversee and organize the various expenses of its business over a certain duration of time. This account can be broken down into sub-accounts so that one can clearly see where money is going and organize the finances accordingly.

Typical examples of expense accounts include Wages expenses, Salary expenses, Supplies expenses, Rent expenses, and Interest expenses. The expense account stores information about different types of expenditures in a company’s accounting records and appears on the business’s profit and loss account.

Expense accounts are the bulk of all accounts used in the general ledger. This is a type of temporary account that is zeroed out at the end of the fiscal year. It is zeroed at the end of the year in order to make room for the recordation of a new set of expenses in the next fiscal year.

This means that the expense accounts only exist for a set period of time- a month, quarter, or year, and then new accounts are created for each new period. This is why the account is considered a temporary account. When a company spends funds (a debit), the expense account increases and the expense account decreases when funds are credited from another account into the expense account.

See also: Accumulated Depreciation on Balance Sheet

Take, for instance, a company paying $800 on the 1st of May for the month of May rent. Because cash was paid out, the asset account Cash will be credited and another account will have to be debited. Since the rent paid will be used up in the current month of May, it is considered to be an expense. Therefore, the expense account, Rent expense will be debited.

However, in a situation whereby the rent payment was made on May 1 for a future month, say June, the $800 debit will go to the asset account, Prepaid Rent. Therefore, all expense sub-accounts like wages expense, utilities expense, salary expense, interest expense, rental expense, supplies expense, and depreciation expense will be a debit entry and not a credit entry.

Why expense is a debit and not a credit

Recall that, credits serve to increase revenue accounts, equity, or liability while decreasing expense or asset accounts whereas debits serve to increase expense or asset accounts while reducing liability, equity, or revenue accounts. Expenses cause the owner’s equity to decrease and as such should have a debit balance. Moreso, because the normal balance of owner’s equity is a credit balance, an expense must be recorded as a debit.

The debit balances in the expense account at the end of the accounting year will be closed and transferred to the owner’s capital account, thereby reducing the owner’s equity. Also, the debit balances in the expense account at a corporation will be closed and transferred to Retained Earnings, which is a stockholders’ equity account.

See also: Common stock in the balance sheet

Examples: expense debit or credit?

The expense account has a natural debit balance and as earlier said, when expenses go up, they are recorded with debit and when they go down, they reduce with a credit. Here are some examples illustrating how an expense is entered as a debit and not a credit.

Journal entry for Cash Expenses

Whenever a company pays for an expense in cash, a journal entry for this transaction has to be made. As the expense increases with a debit, the cash paid will decrease with a credit. This is because cash also has a natural debit balance. Therefore, the journal entry for a $2000 cash expense will be recorded as follows:

Journal entry for Expenses Payable

When a company incurs an expense that has not yet been paid, an entry to accrue this expense is made. The expense is recognized the very moment it is incurred especially when the benefit of the expense is received. Therefore, if the expense is not paid at the point that it was incurred, a payable should be recorded in order to recognize the liability of having to pay the cash at some point later in the future. Therefore, an entry for a $2,000 expense payable accrual will be recorded as follows:

Journal entry for payment of Accounts Payable

Once the payment of Accounts Payable is done, it should be taken off the books. The related entry would be to take off the cash payment from the books and also take off the liability of the Accounts Payable balance. The end result would be that the expense would remain on the income statement, and cash would be removed from the balance sheet. Therefore, an entry for the $2000 payment of Accounts Payable will is recorded as follows:

Journal entry for Advertising Expense

Assume a new company has only one asset (Cash of $20,000) and its owner’s equity is $20,000. The company then pays $1000 for advertising that occurs at the time of payment. In such a case, the company must reduce its Cash account (which has a debit balance of $20,000) by entering a credit of $1000. In order to balance this, the company has to record a debit of $1000 in Advertising Expense:

Assume this was the only transaction in the company for the year. As a result, the balance sheet of the company will report assets of $19,000 and owner’s equity of $19,000. From this example, there are two reasons why Advertising Expense has to be debited. Firstly, the transaction needed a credit to Cash because the asset account was being reduced. Therefore, there had to be a debit recorded in another account, which had to be the Advertising Expense.

Secondly, the owner’s equity and liabilities will usually have credit balances and because expenses reduce the owner’s equity, the Advertising Expense had to be debited for $1000. The double entry requires that another account must be credited for $1000, so the account Cash had to be credited since cash was used.

Journal entry for Salaries Expense

Is salaries expense debit or credit? Assume in a company, the hourly paid employees work the last week of the year but will not be paid until the first week of the next year. The company, at the end of the year, makes an entry to record the amount that the employees earned but have not been paid. Let’s assume during the last week of the year these employees earned $3000, the entry in the journal is recorded as:

Since expenses are almost always debited, Wages Expense is debited by $3000, hence increasing its account balance. The company’s Cash account is not credited by the $3000 because it did not pay the employees yet, rather, the credit is recorded in the liability account Wages Payable.