Question

a) Where do expenses belong in the accounting equation? How does an increase in an expense affect the accounting equation, assuming the expense was paid in cash.

b) Does the net income amount reported on the Balance Sheet always reflect the increase in cash during the year? Explain why or why not.

Answer 1

a) expenses belong to Owner's equity.

Expenses will charge to profit and loss account which will ultimately form part of owner's equity.

When business incur any expenditure and paid in cash, In accounting equation 2 changes will happen.

Asset decreases ( as cash decreases)

Owner's equity also decreases.(expenses debited to profit and loss account and this balance form part of owner's equity)

b)Net income reported in Balance sheet not necessarily reflect the increase in cash during the year. As accounting is based on Accrual concepts all income and expenses pertaining to the period will include in the profit and loss account even though cash is not recieved for the same. Like many non cash items will have impact in the profit and loss account. So it is not necessarily reflect the increase in cash during the year in net income,but It may reflect in most of the time.