Definition of Accrued Expense
An accrued expense is an accounting terminology under the accrual concept which states that expenses need to be recognized and recorded in an entity’s books of account during the accounting period in which they are incurred regardless of the fact whether they are been paid or not leading to simultaneous recognition of liability.
Explanation
Accrued expenses is a term of accounting which means that an incurred expense has been recorded in the books of accounts whether it has been paid or not. It is the result of the accrual method of accounting under which expenses are recorded in the accounting period in which they are incurred. These are presented in the current liabilities section of the balance sheet as it is the current obligation of the business which needs to be settled in the future. These are also known as accrued liabilities. Accrued expenses are only the estimate of the expenses, the real expense may vary from the accrued one which will arrive on the future date. Accrued expenses are recorded only under the accrual method of accounting which states that an expense must be recorded at the time it is incurred unlike in cash accounting where expenses are recorded only at the time of payment. The accrual concept presents a better picture of the profits generated during a given time frame.
Examples of Accrued Expenses
Some examples of accrued expenses are as follows –
- Rent incurred but not paid.
- Commissionincurred but not paid.
- Interest on loan incurred during the month but installment has not fallen due.
- Services received but bot billed.
- Wages and salaries incurred but payment is still pending.
- Taxes incurred.
Accrued Expenses on Balance Sheet
Accrued expenses are recognized in the period of incurrence for which the invoice has not been received yet. When an accrual expense is recognized, it is recognized as an expense in the Income statement, and simultaneously being unpaid, it gets recorded as a liability in the balance sheet. While recoding an accrual expense, the expense ledger gets debited and the accrued liability account gets credited which appears in the balance sheet as the accrued expense is for a limited time period and is classified as a current liability in the balance sheet. Therefore, whenever an expense is accrued it is forms part of in the current liability under the balance sheet. The accrued expense can even form part of long-term liability also if it will get settled over a period longer than one year. Thus the offset of the accrued expense recorded in the income statement will always appear in the liability section of the balance sheet.
There can be n number of accrued expenses in the balance sheet, some of which are as follows:
- Interest Payable: These are the interest expenses that have been accrued by the business but are not paid in the period. To record them an adjusting entry needs to be passed.
- Salaries and Wages Payable: These are employee benefit expenses of the company due to the employees for services and are generally paid in the early week of next month.
- Other Expenses: These include a variety of expenses such as rent payable, royalty and commission payable, utility bills payable, tax payable, etc.
Recording Accrued Expenses
Accrued expenses can be recorded by debiting the concerned expense account (Nominal A/c) and crediting Accrued expense A/c for recognizing accrued expense liability. Let us understand the recording of accrued liability by this example-
Jumbo Inc. borrowers a $5,00,000 loan on 1 March for business purpose from the bank. The loan agreement requires Jumbo Inc.to to repay the $5,00,000 loan on 31 July along with a $5,000 interest for the five months from March to July. Until 31 July the company is not going to have the invoice which could be processed and is not going to pay the interest of $5,000 until 31 July.
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So the recording of the accrued expenses of interest will be as follows –
It is necessary to adjust the interest accrued as without adjusting income with interest accrued for this period, the company’s statements would not portray a fair view. In order to get true statements, accrued interest expense of one-fifth of $5,000 needs to be reported in the current period on the basis of accrual accounting.
Entry Processing:
The entry will be processed by debiting $1,000 to interest expense and crediting the interest payable account with $1,000. Interest expense account will be charged in the income statements while expense payable will be shown as interest payable under the balance sheet.
Advantages of Accrued Expenses
Some of the advantages are given below:
- The first and foremost advantage of accrued expenses is that it helps in the preparation and presentation of true and fair financial statements.
- It helps in correctly stating the company’s profit in absence of which income would have been overstated.
- Accrued expenses are recorded under the accrual basis of accounting, therefore the transactions are recorded immediately at the time of happening. This reduces the chances of mistakes or errors to almost zero.
- Liabilities become more transparent and are easily accessible for the auditors and for other users of the financial statements.
- Under this, all obligations of the company are clearly visible along with the dates clearly indicating the date at which the liability will be due.
- It helps the owners and other stakeholders to understand better, the performance and financial position of the business.
Difference Between Accrued Expense and Accounts Payable
Accrued expenses are the expenses which a company has incurred i.e. service is availed or goods are procured but the supplier have not been paid. These are recorded by the accountant in order to have a better understanding of the company’s liabilities and will result in good decisions regarding available fund utilization.
While on the other hand accounts payable are the debts of the company for trading goods or raw material procured but the payment is still due to its suppliers or creditors. Accounts payable is generally used in respect of trading commodities whereas accrued expense is an umbrella terminology where any incurred but not paid expenses will be recognized and presented. Both are recorded in the balance sheet under the head current liabilities.
Conclusion
The accrued concept is a concept of accrual concept of accounting that requires recognition of each expense during the period under which they are incurred. It helps in increasing the accuracy of financial statements as recognition of accrued expenses results in matching expenses with the revenue generated during an accounting period. Also, it helps stakeholders to derive knowledge of obligations due as on balance sheet date. Accrued expenses are generally for expenses incurred but not paid whereas accounts payable is used for unpaid trading goods/ services.
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