Assets vs Expenses
   

The basic distinction between assets and expenses is this: If by making the cash disbursement, the entity buys something that benefits future periods, the debit part of the entry is to an asset account. This asset account appears on the balance sheet as of the end of the period. Land, buildings, furniture, equipment, and motor vehicles are assets. So are stock, prepaid rent, prepaid insurance, and other items that are paid for in advance of the period in which they provide benefits.

If the item bought is used up in the current period, the debit is to an expense account. Payment for the services provided by employees (salaries and wages), for telephone and electricity used in the current period, and for other services used in the period are expenses.

Shortcuts:


However, this practice is not always followed exactly. Some items that theoretically should be recorded as assets are debited to expense accounts. If the item were debited originally to an asset account, it must be debited to an expense account in the later period, or periods, in which it is used up. This process causes additional record keeping. If the debit is made to expense immediately, this additional record keeping is avoided.

Consider pencils as an example. In principle, pencils are an asset. If you follow the accrual principle strictly, you debit an asset account when the pencils are purchased, and you debit an expense account in each month these pencils are used. As a practical matter, this amount of record keeping is not worthwhile.

You debit the cost of pencils to an expense account when you buy them. The amount is small. Also, if the amount of supplies purchased tends to be roughly the same from one month to the next, the effect of debiting an expense account immediately is about the same as with the alternative of first debiting an asset account and later transferring the asset to an expense.

Supplies, small tools, and similar items usually are debited to expense accounts when they are purchased. You may decide to debit the payment of property rates to an expense account, even though the rates payment applies to several months. You can decide to debit a payment for insurance protection to an expense account in the month you pay the bill, even though the insurance protection applies for a full year. The choice is up to you.

Materiality Principle:

In making these choices, you are applying the materiality principle, which is an accepted accounting principle; an entity can depart from the accrual principle if the effect of doing so is not material. The effect is not material if it does not mislead the user of accounting information. So, if a shortcut will give you approximately the information you need about how your entity has performed and what its condition is, you should use it and reduce the amount of record keeping.


Exercise caution in treating "chunky" disbursements as expenses. Chunky disbursements are those that occur at infrequent intervals, such as the insurance premium or the property rates mentioned above. If you record these amounts as expenses in the month in which you paid the bill, the income reported in that month will be artificially low, and the income in the other months will be higher than was actually the case.