Accrued Expense Journal Entry
Accrued expense refers to the expense that has already been incurred, but for which the payment has not yet been done. The term “accrued expense journal entry” comes into play when in lieu of the expense documentation, a journal entry is made to recognize an accrued expense in the income statement along with a corresponding liability that is generally categorized as a current liability in the balance sheet.
- If the journal entry is not created, then the expense will not at all appear in the financial statements of the company in the period of occurrence, which will result in a higher reported profit in that period.
- In short, an accrued expense journal entry is recognized in the financial statements of a company in order to enhance the accuracy of the statements, such that the expense is matched with the revenue with which it is associated.
Example of Accrued Expense Journal Entry
Let us take the example of the accrued expense journal entry. Let’s say a company XYZ Ltd that has paid interest on the outstanding term loan of $1,000,000 for the month of March 2018 on 5th April 2018. The interest is charged at 1% per month. Determine the accrued expense journal entry for the example transaction given that XYZ Ltd reported accounting year at the end of 31st March 2018.
As per matching concept, XYZ Ltd will record the interest expense of $10,000 (= 1% * $1,000,000) in the financial statements of financial year ending on 31st March 2018, despite of the fact that the interest was actually paid in the next accounting period, because it is related to the period ending on 31st March 2018. T
he following accounting entry will be recorded to account for the interest expense accrued:
The accounting entry will be reversed on the day of payment of the interest, i.e. 5th April 2018, and the following accounting entry will be recorded in the subsequent financial year:
Advantages of Accrued Expense Journal Entry
The advantages of accrued expense journal entry are:
- The primary advantage of accounting an accrued expense journal entry is the true representation of the company’s profit which otherwise will be overstated.
- Given that the financial transactions are recorded immediately as it occurs, the chances of discrepancies or errors is almost zero. Also, the information remains easily accessible for audit or similar activities because all the transactions are recorded at all time. Under the accrual basis of accounting, liabilities become more transparent.
- Another advantage of the accounting of accrued expense journal entry is that the users of the financial statement can clearly see all the obligations of the business along with the dates on which it will become due. Under the cash basis of accounting, the full extent of such transactions is not quite clear.
- Unlike cash accounting, accounting of accrued expense journal entry is based on the double entry system. It means that while one account is being debited, another account is being credited. As such, a financial user can see that one account is decreased while the other one is increased. It basically enhances the accuracy of the accounting system that makes things easier during audits.
- Another benefit of accounting of accrued expense journal entry is the fact that accrual accounting is recognized by GAAP and as such a large number of companies follow the practice of recording accrued expense.
Disadvantages of Accrued Expense Journal Entry
The disadvantages of accrued expense journal entry are:
- Since accrual accounting is a very difficult task for companies to record because every time a transaction happens, there has to be an entry made in the books of accounts. As such, maintenance of accounting of accrued expense journal entry is a difficult job.
- In the case of a huge business, there are several hundred and thousands of financial transactions recorded in a single day. Maintenance of so many accrued expenses every day, day after day is a difficult job for an accountant.
Important Points to Note about Accrued Expense Journal Entry
A company usually recognizes an increase in accrued expense immediately as it occurs. It is credited to accrued expense in the liability side of the balance sheet. The increase in accrued expense is complemented by an increase in corresponding expense account in the income statement. Hence, the company will then debit the expense account and insert it as an expense line item in the income statement. Therefore, an increase in accrued expense has a reducing effect on the income statement.
On another hand, a decrease in accrued expense happens when a company pays down its outstanding accounts payable on a later date. To recognize a decrease in accrued expense, a company will debit the accounts payable in order to decrease the accounts payable on the liability side and will credit the cash account on the asset side by the same amount. It is to be noted that the cash paid in the current period is not an expense for this period because the corresponding expense has happened and subsequently recorded in the previous accounting period. Therefore, a decrease in accrued expense has no effect on the income statement.
Although accrued expense is not paid in the same period when it occurs, it is captured in the balance sheet for the period. This is important from an accountant’s point of view as it helps him to maintain a transparent accounting system in concurrence with matching principle. Also, from an investor’s perspective, accrued expense helps in ascertaining the true picture of the company’s profit.
This has been a guide to Accrued Expense Journal Entry and its meaning. Here we discuss Accrued Expense Journal Entry examples along with advantages & disadvantages. You can learn more about accounting from the following articles –