Journal Entry For Accrued Expenses
Accrued expense Journal Entry is the journal entry passed to record the expenses which are incurred over one accounting period by the company but not paid actually in that accounting period where expense account will be debited and the accrued liabilities account will be credited
Accrued expense refers to the expense that has already incurred but for which the payment is not made. This term comes into play when in place of the expense documentation, a journal entry is made to recognize an accrued expense in the income statement along with a corresponding liability that generally categorizes 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, this journal entry recognized in the financial statements enhances the accuracy of the statements. The expense matches the revenue with which it is associated.
Example of 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 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 the matching concept, XYZ Ltd will record the interest expense of $10,000 (= 1% * $1,000,000) in the financial statements of the financial year ending on 31st March 2018, even though the interest was paid in the next accounting period, because it is related to the period ending on 31st March 2018. T
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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:
- The primary advantage is the accurate 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 are almost zero. Also, the information remains easily accessible for audit or similar activities because all the transactions are recorded at all times. Under accrual accounting, liabilities become more transparent.
- Another advantage is that the users of the financial statement can 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 entirely clear.
- Unlike cash accounting, accounting of accrued expense journal entry base on the double-entry system. It means that while one account debits, another account credits. As such, a financial user can see that one account decreases while the other one increases. It enhances the accuracy of the accounting system that makes things easier during audits.
- Another benefit is the fact that GAAP recognizes accrual accounting, and as such, a large number of companies follow the practice of recording accrued expenses.
- Since accrual accounting is a challenging 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, the 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.
Essential Points to Note about Accrued Expense Journal Entry
A company usually recognizes an increase in accrued expenses immediately as it occurs. It is credited to accrued expenses on 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 the other hand, a decrease in accrued expenses happens when a company pays down its outstanding accounts payable on a later date. To recognize a decrease in accrued expenses, a company will debit the accounts payable 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 expenses does not affect 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. It is crucial from an accountant’s point of view as it helps him to maintain a transparent accounting system in concurrence with the matching principle. Also, from an investor’s perspective, accrued expense helps in ascertaining the accurate picture of the company’s profit.
This article 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 –