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Accrued Expenses and Accrued Expenses Payable

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Accrued Expenses and Accrued Expenses Payable

Accrued Expenses

A business expense that has been incurred by the entity against which it is yet to make any payment.

If the said expense has not yet been entered in the entity’s accounting records then the entity would be required to make an adjusting entry in its books to record the said business expense which would see a relevant expense account being debited while a relevant payable account being credited.

Simply put accrued expenses can be defined as expenses that an entity accounts for in its books in the accounting period in which it happens rather than the period in which they are invoiced or paid for. Accrued expenses basically represent an entity’s obligation to make future payments either through cash or bank. Businesses usually present accrued expenses on their statement of financial position under the head of current liabilities. These are also known as accrued liabilities. In some cases, accrued expenses are estimated by entities and therefore can differ from the invoices provided by suppliers at a later date after the end of a month or an accounting period.

Understanding Accrued Expenses in Detail

An example of an accrued liability is when an entity buys an item for office use from a supplier but is yet to receive any invoice or make any payment to the supplier against the said purchase. Other examples of accrued liabilities include warranties on services or products received, interest payments on loans, salaries and other benefits, taxes, and utilities; all of which have been incurred by the entity but against which no bills/ invoices have been received (if applicable) and no payments have been made.

Accrued liabilities are the complete opposite of prepaid expenses. The term prepaid expenses in the context of accounting can be described as expenses that an entity pays for in advance. For example, an entity makes a payment against office rent for the month of January in the last week of December. While prepaid expenses usually represent current assets, accrued expenses are recognized as liabilities, on an entity’s statement of financial position.

In order to better understand accrued expenses, let’s assume that an entity has a policy of paying salaries to its staff members in the first week of the following month for services provided in the prior month. The entity paid salaries to most of its staff members for the month of August in the first week of September. However, some of the employees received their salaries for the month of August in the last week of August. If the company prepares its income statement for the month of August only on the basis of cash received and paid then it means it has not accounted for the total accrued salary expense for the month of August in its accounting ledgers.

However, the entity should ideally record transactions in its accounting ledgers on an accrual basis which means the transactions should be recorded when they occur instead of when cash is received or paid.

Therefore, ideally, the company should pass an adjusting entry in its books so that a more accurate picture of the entity’s financial performance could be presented to its stakeholders through its income statement/ statement of profit or loss and statement of financial position.

The adjusting entry in case the company prepares its accounts on a cash basis would be as follows:

Account Head Debit $ Credit $
Salary Expense XXX
Salary Payable XXX

 

The above-stated entry would help the entity in recording accrued salary expense in its financials for the month of August.

Difference between Cash Accounting and Accrued Accounting

Accrual accounting when compared with cash accounting is more labor-intensive as it requires more entries to be made in accounting ledgers. However, the method helps in providing a better picture of a company’s financial affairs. This more complete and accurate picture helps the company’s stakeholders and users of the financial statements in better understanding a company’s existing financial performance and in predicting its future financial performance and position.

The accrual basis of accounting is pretty different from cash accounting, as financial transactions and events are recorded in cash accounting only when cash is received or paid.

Accrued Expenses Payable

Accrued expenses payable is a liability account that reflects the amount a company owes for expenses incurred against which payment is yet to be made by the company. For example, salary expense for a particular month that is yet to be paid by the entity will be recorded in an expense account on the income statement and an accrued payable account on the entity’s balance sheet.

The said account is used by an entity when it records its financial transactions and events using the accrual method of accounting. Accrued expenses or liabilities occur when an entity incurs expenses for which it is yet to be billed. For example, an entity purchases stationery items for office use in January but makes a payment against the said purchase in February (when it received the invoice). An accrued liability basically refers to an entity’s obligation to pay against the expense accrued in a specific accounting period, in the near future.

The accrual method of accounting helps in providing a more clear and accurate picture of an entity’s financial affairs.

Examples of Accrued Liabilities

Some common examples of accrued liabilities include the following:

  • Accrued Payroll: you pay your staff in arrears (e.g., salaries for the month of August paid in September.
  • Accrued Payable Against Goods/Services: you receive goods/ services against which the supplier doesn’t provide an invoice until after the end of a specific accounting period.
  • Accrued interest: you owe interest on an outstanding loan amount for a specific accounting period against which payment is yet to be paid.
  • Accrued liabilities: you have used utilities for a specific month or accounting period against which you haven’t been billed yet.

Let’s assume that a Company ABC buys office supplies at the end of its financial year which is December 31. The entity does not receive a bill from the supplier against the aforementioned purchase until January 20. ABC makes payment to the supplier on January 22. The company records all its transactions and events using the method of accrual accounting.

First, the entity would be required to accrue the expense relating to the purchase of office supplies at the end of its financial year through the following adjusting entry:

Account Head Debit $ Credit $
Office supplies (expense account) XXX
Accrued expense (Liability account) XXX

When the entity pays the supplier in full then it would be required to incorporate the following entry in its books:

Account Head Debit $ Credit $
Accrued expense (Liability account) XXX
Cash/ bank XXX

Accrued Expense Payable and Accounts Payable

Accounts payable and accrued expenses/ liabilities are similar but not quite the same. Both accounts payable and accrued expenses/ liabilities are current liabilities which means both are expected to be settled within a year. The difference between the two mainly lies at the timing of the invoicing.

Accounts Payable: Expenses incurred by an entity against which it has received bills/ invoices.

Accrued Expenses/Liabilities: Expenses incurred by an entity against which it has not yet been billed.

 

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