Why Expenses Are Debited
Expenses cause owner's equity to decrease. Since owner's equity's normal balance is a credit balance, an expense must be recorded as a debit. At the end of the accounting year the debit balances in the expense accounts will be closed and transferred to the owner's capital account, thereby reducing owner's equity. (At a corporation, the debit balances in the expense accounts will be closed and transferred to Retained Earnings, which is a stockholders' equity account.)
Example of Why Expenses Are Debited
To illustrate why expenses are debited, let's assume that a new company has only one asset, Cash of $10,000, and its owner's equity is $10,000. The company then pays $500 for advertising that occurs at the time of payment. The company must reduce its Cash (which has a debit balance of $10,000) by entering a credit of $500. To comply with double-entry accounting, the company must record a debit of $500, which will be entered in Advertising Expense. Let's also assume this was the only transaction for the year. As a result, the company's balance sheet will report assets of $9,500 and owner's equity of $9,500. As you can see, there are two reasons why Advertising Expense had to be debited:
- The transaction required a credit to Cash since this asset account is being reduced. Therefore, there must also be a debit recorded in another account, namely Advertising Expense.
- The owner's equity and liabilities will normally have credit balances. Since expenses reduce owner's equity, Advertising Expense must be debited for $500. Therefore, double entry requires that another account must be credited for $500. Since cash was used, the account Cash will be credited. This is logical since this asset's normal debit balance must be reduced.