Question

What effect does expense recognition have on the accounting equation?

Specifically what accounts in the equation are affected by recognizing expenses under the accrual basis?

Answer 1

Accounting equation is given by:

Assets = Liabilities + Equity

Recognition of expense on accrual basis decreases profit and loss account i.e equity and increases liability account. So, overall it will have nil effect on accounting equation because on the one side, it increases liabilities account and on the another side it decreases equity account. For example, Utilities expenses for the month of December of $1500 is to be on 5th January another year. Here, we need to recognise the expense as on December 31st i.e.at year end. Journal entry for the same will be:

Utilities Expense Dr $1500

Utilities payable Cr $1500

Uitilities expenses will be transferred to profit and loss account and decreases the equity account of company. Utilities payable will increase the current liabilities of company.So, effect on accounting equation will be:

Assets = Liabilities + Equity

0 = 1500 + (1500)

0 = 0 i.e. nil effect