When you record an expense, it most obviously appears within a line item in the income statement. The income statement shows the financial results of a business for a designated period of time. An expense appears more indirectly in the balance sheet in the following ways:
- An expense reduces profits, so when you record an expense, the retained earnings line item within the equity section of the balance sheet will always decline by the same amount as the expense.
This change in equity always occurs. In addition, either the asset side of the balance sheet will decline or the liabilities side will increase by the amount of the expense, thereby keeping the balance sheet in balance. Here are examples of where the changes may occur:
- Assets. Cash declines if you paid the expense item in cash, or inventory declines if you wrote off some inventory.
- Contra asset accounts. The accumulated depreciation contra account increases if you created a depreciation charge.
- Liabilities. Accrued expenses increase if you created an expense accrual, or accounts payable increase if you recorded a supplier invoice that is not yet paid.
In short, expenses appear directly in the income statement and indirectly in the balance sheet. It is useful to always read both the income statement and the balance sheet of a company, so that the full effect of an expense can be seen.