all right great in our previous lesson
we saw that income does not equal cash now we’ll see that a similar observation
can be made for expenses expenses that we see in the income statement are
recorded during the period in which they are incurred regardless of when the
transfer of cash occurs similar to what we saw for revenues cash can go out at
before or after we recognize an expense let’s
consider the following example the firm that sells office equipment pays 1000
for rent we’ll need to draw three T accounts cash
rent and trade payables now let’s consider the first scenario when the
payment and the expense recognition occur at the same time we will pay one
thousand for rent our cash will decrease by one thousand
and because it is an asset we’ll have to credit it for 1,000 and then we’ll debit rent for 1,000
because it is an expense and it increases let’s think of the second scenario the
firm could delay its payment by let’s say 60 days it receives an invoice for
rent but is unable to pay it and communicates that it will pay its
obligation in 60 days in this case the firm will debit its rent account for
1,000 and will register that it owes 1,000 to its landlords will have to
credit trade payables for 1,000 then after sixty days have passed the
firm manages to find the money and pays its rent will have to credit cash and
debit trade payables for one thousand the debt has been paid in the third
scenario the landlord asks the company to pay its rent in advance it would then
have to pay its rent before recognizing an expense let’s add an additional t
account that will be named prepaid expenses here we will show that we have paid for
a future expense this is an asset because it represents a claim that we
have our landlord is supposed to provide us a service and he technically owes us
at this point so at first we’ll have cash going for
1,000 and an increase in prepaid expenses for 1,000 both of them are
assets we’ll have to credit cash because it
decreases and then debit prepaid expenses then when the time comes and we
register rent as an expense will credit prepaid expenses for 1,000
and debit rent for the same amount here we are the end result is the same but
the timing of payments in the three cases was considerably different this
lesson reinforces our message from before there is a difference between the
recognition of income and expenses and cash payments