Accrued Expense Meaning
An accrued expense is the expenses which is incurred by the company over one accounting period by the company but not paid in the same accounting period and therefore recorded in books of accounts wherein expense account will be debited and the accrued expense account will be credited.
In simple words, Accrued Expense refers to the expenses which have been incurred, and the business owes cash for such expenses. It applies to those expenses for which actual payment is not yet made. As such, liability for such expenses is created and shown on the Balance Sheet liability side as accrued liabilities. Such liability decreases when the business pays cash to satisfy it.
The Principal of Accrual Accounting requires that expenses are recorded as the firm incurs them irrespective of the fact whether actual cash has been paid or not. A most popular example includes Salaries and Wages payable as companies typically pay their employees at a later date for work done in the prior month.
Accruals Expense requires an accounting entry when the goods or services are received and requires one or more offsetting entries as the exchange is completed. In short, under Accrual Expenses, the expenses are first recorded, and cash payment is made later.
Types of Accrued Expenses on Balance Sheet
#1 – Salaries and Wages Payable
These are the income due, to the employees for the work done and are usually paid on a weekly or monthly basis. For instance, the work done by employees of Alex International is paid in the next month. Accordingly, it should be recorded by debiting Wages and Salaries Expenses and crediting Accrued Expenses and by making an offsetting entry by debiting these expenses and crediting Cash when payment is made.
#2 – Interest Payable
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Let’s understand the same with the help of an example:
XYZ Company borrowed $100,000 on October 1, 2018, and requires making the complete repayment on January 31, 2019, along with interest $5000. As of December 31, 2018, it is not necessary for XYZ to make any interest expenses. However, $3750 ($5000*3/4) of Accrual expenses has occurred and will consist of debt of $3750 of interest expense and a credit of $3750 to Interest Payable Account.
#3 – Other Expenses
Other examples may include the following
- Rent owed by the business but not yet paid.
- Commission and Royalties are yet to be paid by the business.
- Utilities and Taxes owed but not yet paid by the business.
Starbucks Accrued Expense on Balance Sheet
source: Starbucks SEC Filings
The list of accrued expense in Starbucks is –
- Accrued Compensation and Related Costs
- Accrued Occupancy Costs
- Accrued Taxes
- Accrued Dividends Payable
- Accrued Capital and other Operating Expenditures
Accrued Expenses on Balance Sheet Example
Gluon Corporation operates in the Pharmaceutical Industry and pays a fixed 2% commission on Monthly Turnover payable on the 7th day of next month. The Company achieved a turnover of $40000 during the month ending December 31, 2018. However, the commission was payable on January 7, 2019, and as such, the following journal entries will be passed to record the Accrual commission of $800 ($40000*2%)
Matija Square has a five-day working week, and payday is Friday of each week. Weekly salaries are $5000. The current Accounting period ended on Thursday, December 31, 2015. Matija Square will make adjusting journal entries to account for the Wages accrued $4000 ($5000*(4/5)).
Flour International utilized the services of an Electrician for repairing the light fixtures in their retail shop on December 24, 2018, which resulted in an expense amounting to $300.The electrician sent the bill to the Flour International on January 3, 2019. Flour International will report the $300 expenses as Accrued Expenses on its Balance Sheet and will reduce the associated amount of $300 from its Income Statement on December 31, 2018, however, the actual payment will be made on January 3, 2019.
- It helps in the proper measure of the performance of a business during a reporting period as it accounts for the expenses incurred (although not due to be paid) with the associated revenues of the reporting period.
- It helps in avoiding misstatement of the financial performance of the business.
- It enables various stakeholders to analyze the business perform better and also gain more confidence of Investors as the same is GAAP compliant.
- Accrual Expenses reported by the business are based on estimates, and actual liability may vary from the estimates.
- It can be used as a tool to suppress income and reduce taxes by the business.
- Liabilities of the Business will be understated if Accrual Expenses are not accounted for in the Balance Sheet as a Short Term Current Liability.
- Expenses will not be reported in the Income Statement to which they belong, which will ultimately result in overstating profits by the business.
What does Change in Accrued Expenses Signify?
Changes in Accrued Expenses should be closely monitored by those who are analyzing the financials of the business. An increasing trend in such expenses is a sign that the business is not honouring the expenses and as such the profit reported is overstated as there will be an increase in cash flow and such increase in Accrued expenses to the extent to which they relate to the period must be adjusted from reported Profits to get a clear picture of the Profit earned by the business in the period to which such expenses are associated.
Accrued Expenses are expenses that occurred during the accounting period but not paid by the business during the period and are to be paid at a later date. These expenses are reflected on the Balance sheet of the business under Short Term Current liabilities and should be closely watched and monitored by those tracking the business. Its performance and changes in such Expenses should be duly accounted for in the profit reported by the business.
This article has been a guide to the meaning of Accrued Expenses in the Balance Sheet. Here we discuss Accrued expenses accounting examples along with its types and explanation. You can learn more about accounting from the following articles –