Accrued Expense Meaning
In accounting, Accrued Expenses are expenses that have been incurred and for which the payment has not yet been made. As a result, liability for these expenditures is created and recorded as accrued liabilities (short term) on the balance sheet liability side. When a business pays cash to settle such a responsibility, the expense account will be debited and the accrued expense account will be credited.
Understanding Accrued Expense
The Principal of Accrual AccountingPrincipal Of Accrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. requires that expenses are recorded as the firm incurs them irrespective of the fact whether actual cash has been paid or not. 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 periodReporting PeriodA reporting period is a month, quarter, or year during which an organization's financial statements are prepared for external use uniformly across a period of time in order for the general public and users to interpret and evaluate the financial statements.. Also, it helps in avoiding misstatement of the financial performance of the business and enables various stakeholders to analyze the business perform better and also gain more confidence of Investors as the same is GAAPGAAPGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors. compliant.
A most popular example of accrued expense includes Salaries payableSalaries PayableSalary payable refers to the liability of the company towards its employees against the amount of salary of a period that became due but has not been paid yet to them by the company and it is shown in the balance of the company under the head liability. as companies typically pay their employees at a later date for work done in the prior month.
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
It refers to the interest expenses which have occurred but not yet due to being paid by the business. An adjusting entry needs to be passed to record the impact of such an accrued interest.
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
source: Starbucks SEC Filings
The list of accrued expense in Starbucks is –
- Accrued Compensation and Related Costs
- Accrued Occupancy Costs
- Accrued Taxes
- Accrued Dividends PayableDividends PayableDividend payable is that portion of accumulated profits that is declared to be paid as dividend by the company's board of directors. Until the dividend declared is paid to the concerned shareholders, the amount is recorded as a dividend payable in the head current liability.
- Accrued Capital and other Operating Expenditures
Examples of Accrued Expenses
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 periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance. ended on Thursday, December 31, 2015. Matija Square will make adjusting journal entriesAdjusting Journal EntriesAdjusting Entries in Journal is a journal entry made by a company at the end of any accounting period on the basis of the accrual concept of accounting. Companies are required to adjust the balances of their various ledger accounts at the end of the accounting period in order to meet the requirements of the various authorities' standards. 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 SheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. 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.
Changes in Accrued Expenses
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 flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. 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 are incurred but not paid by the business during the accounting period. These expenses are reflected on the balance sheet of the business under short term 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 Accrued Expenses and its meaning. Here we discuss examples of accrued expenses on the Balance Sheet and their types. You can learn more about accounting from the following articles –