A friend comes to you with the following plight: “I’m confused. An asset is something positive, and it is increased with a debit. However, an expense is something negative, and it is also increased with a debit. I don’t get it.” How can you straighten your friend out?
To help your friend understand the confusion between assets and expenses in accounting, let's break it down step by step.
1. Understanding Debits and Credits:
In accounting, we use a system known as double-entry bookkeeping, where every transaction affects at least two accounts. Debits and credits are used to record these transactions. Debits are entries made on the left side of an account, while credits are entries made on the right side of an account.
2. Assets and Debits:
Assets are resources that the company owns and controls, which have future economic value. Examples of assets include cash, inventory, buildings, and equipment. To increase an asset account, we would make a debit entry.
For instance, let's say a company receives $1,000 cash from a customer, this transaction will increase the cash asset account. We would record a debit entry of $1,000 on the cash account and a credit entry of $1,000 on another account (like revenue or accounts receivable) depending on the nature of the transaction.
3. Expenses and Debits:
Expenses, on the other hand, are costs incurred in the process of generating revenue (e.g., salaries, rent, utilities). Expenses decrease the company's net income and, therefore, reduce equity. To record expenses, we also make debit entries.
For example, let's say a company pays $500 for rent expense. This transaction will increase the rent expense account. We would record a debit entry of $500 on the rent expense account and a credit entry of $500 on the cash or accounts payable account, depending on the payment method.
4. Different Perspectives:
The confusion arises because assets and expenses are opposite in terms of their overall effect on equity and net income.
- Assets have a debit balance and are viewed as positive because they represent the company's resources.
- Expenses have a debit balance but are seen as negative because they represent the costs incurred in generating revenue. Higher expenses reduce net income and, consequently, equity.
In summary, while both assets and expenses are increased by debit entries, their impact on the overall financial position of the company and its net income differs. Assets are positive (positive balance) because they represent resources owned, while expenses are negative (reduce net income) because they are costs incurred in generating revenue.