To Increase an Expense Is It a Credit or Debit?
Gain clarity on fundamental accounting principles. Understand how financial transactions, including expenses, are precisely recorded and affect your books.
Understanding accounting principles is important for managing financial records. Grasping how financial transactions are recorded provides clarity on a company’s financial health, helping track resources, obligations, and operational performance.
Understanding Debits and Credits
In double-entry accounting, debits and credits are the two components of every financial transaction. These terms refer to the left and right sides of an accounting entry. Their effect depends on the account type; “debit” does not always mean an increase, nor “credit” a decrease.
For every financial transaction, total debits must always equal total credits. This ensures financial records are balanced. Debits and credits categorize and record economic activity, providing a structured method for tracking account changes.
The Accounting Equation and Account Behavior
The accounting equation, Assets = Liabilities + Equity, forms the basis of double-entry accounting. It illustrates the relationship between what a business owns (assets), what it owes (liabilities), and the owners’ claim (equity).
Accounts are categorized by their nature, each having a “normal balance” indicating whether it increases with a debit or a credit. Asset accounts (e.g., Cash, Accounts Receivable, Equipment) carry a debit balance, increasing with a debit and decreasing with a credit. Conversely, liability accounts (e.g., Accounts Payable, Notes Payable) and equity accounts (e.g., Owner’s Capital, Retained Earnings) have a credit balance; they increase with a credit and decrease with a debit.
Revenue accounts also increase with a credit and decrease with a debit. Expense accounts (e.g., Rent Expense, Utilities Expense, Salary Expense) decrease equity and have a normal debit balance. To increase an expense account, a debit entry is made, and to decrease it, a credit entry is recorded.
Recording Expense Transactions
When a business incurs an expense, the expense account is increased through a debit entry. This debit signifies the cost incurred in generating revenue or operating the business.
A corresponding credit entry must be made to another account to maintain the balance. For instance, if a business pays its monthly rent, the Rent Expense account is debited. The Cash account is credited, as cash is an asset that is decreasing.
Similarly, when a utility bill is received but not yet paid, the Utilities Expense account is debited. The Accounts Payable account, a liability, is credited. For employee salaries, the Salary Expense account is debited, and the Cash account or Wages Payable account is credited, depending on whether salaries are paid immediately or accrued.
How Expenses Affect Financial Results
Expenses play a direct role in determining a business’s profitability. These costs are reported on the income statement, which summarizes a company’s revenues and expenses over a specific period.
When expenses are recognized and recorded, they directly reduce a business’s net income. For example, if a company generates $10,000 in revenue and incurs $7,000 in expenses, its net income for the period would be $3,000. Higher expenses, relative to revenue, lead to lower net income or even a net loss.