Let me explain to you what an Expense is and what is an Asset. When money is spent, it becomes an Expense or it creates an Asset. So when money goes out of business it is either becoming an Expense or creating an Asset. Let us have a look at a few Examples.
- Six month’s salary in advance. Suppose you have paid an employee six months’ salary in advance. Is it an Expense or an Asset?
- Machinery purchased and destroyed in two months. Is it an Expense or an Asset?
Most of you will get confused. Some will say six month’s salary paid in advance is and expense and Machinery purchased and destroyed in two months is an Asset. Whether money spent is an expense or an asset depends actually on the life of the item being considered. Let me explain this in detail. Let us start with a simple example.
Example: (a) Suppose you buy something and it lasts for 10 months. Is it an Expense or an Asset?
(b) How about something you bought and it lasted for 10 days. Is it an Expense or an Asset?
|Item purchased on||Life||Balance Sheet prepared on||Expense or Asset|
|a) 01 January ‘14||10 months (31 Oct ’14)||31 December ‘14||Expense|
|b) 27 December ‘14||10 days (05 Jan ’14)||31 December ‘14||Asset|
Well in this case (a) is an expense and (b) is an Asset. To keep it simple as I always do, I would like to replace the word life of an item with consumption. If an item that is purchased is consumed before the Balance Sheet is prepared it becomes an expense. If the item which is purchased and not been consumed before the Balance Sheet is prepared, then it becomes an Asset.
Now you might have a question. What if an item is partially consumed? Well whatever is consumed becomes an Expense and the part that is not consumed is an Asset.