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What is the Difference between Cost and Expense? - Accounting Questions Answered

A cost incurred can be either an asset, or an expense or both depending on the timing of accounting transactions. An expense is a cost that is expired and is incurred to the company (i.e. the company has already paid for the expense). Also, the expense was necessary for the company to earn revenues. Let’s take a look at some examples to show the differences between expense & cost.

A corporation pays $10,000 for insurance of its manufacturing plant in advance for a 1 year policy term. Initially, this $10,000 cost is reported as a Current Asset on the balance sheet and is known as “Prepaid Insurance.” Every month, the cost ($10,000 / 12 months) = $834 is moved from Prepaid Insurance to Insurance Expense. Here are the set of journal entries:

January 1st, 2009

Account Name

Dr. Prepaid Insurance   $10,000  
  Cr. Cash   $10,000
To record the advance payment of $10,000 insurance term policy for 1 year.

January 31st, 2009

Account Name

Dr. Insurance Expense   $834  
  Cr. Prepaid Insurance   $834
To record expense incurred for 1 month of insurance.

The unexpired portion of Prepaid Insurance will continue to be reported as Current asset on the balance sheet, while the used portion will be transferred to the income statement as ‘Insurance expense.’

A retailer’s purchase of goods will be recorded as Merchandise Inventory on the balance sheet. However as the inventory is sold, it will be moved from the asset account to an expense account called Cost of Goods Sold. This is made possible by the matching principle of GAAP.

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