Do you rely on credit cards for making significant payments? If you also find credit cards to be a life saviour, then you should learn about accrued expenses for your business. Credit cards have made transactions a smooth process. You can easily invest in your necessities and pay for them later.
Similarly, accrued expenses are the ones that a business uses but does not have to pay for in advance. The easiest way to understand their nature is through salaries. This is the money that an employee earns during a fixed time and is paid later.
This provision has its set of perks and drawbacks. There are several dimensions that you need to know about. Read this article to understand the technicalities and functions of accrued liabilities accounting.
What are Accrual Expenses?
Accrued expenses are those that a business incurs but has not paid for. It can be understood as the functioning of a credit card. It means that the goods or services can be used instantly, but the payment is done later. They are recorded as liabilities on the balance sheet because they have to be paid for in the future.
Accrued revenue comes up when a business has provided a service to a customer that earns revenue. However, the customer has not yet paid for this service. Even though the payment is pending, the company considers accrued revenue as earned revenue in the receivables balance sheet, reflecting their entitlement to the income.
Accrued revenue is a current asset that is recorded for sales products shipped or services delivered that have not been billed or paid for yet. The credit side of the adjusting journal entry is to record revenue. Accrued expenses are called current liabilities because the payment is due within one year of the transaction date. The date on the invoice is what you consider to be this date.
The GAAP revenue recognition principle in financial accounting requires recognising revenue when performance obligations are completed. An accrued revenue reversal entry can be made when the customer is invoiced to record the revenue for product sales or services with the accounts receivable account instead of accrued revenue. Some of the most common examples of accrued expenses are:
- Salaries- They are earned by employees in a pay period but paid later.
- Utilities- Services are used, but the bill has not arrived.
- Rent- It is paid in advance or depends on the agreement.
- Interest- the accrued on loans or other borrowings.
- Taxes- they are owed but not paid beforehand.
Types of Accounts Related to Accrued Expenses
There are many types of accounts that are related to accrued expenses. Each of these accrued liabilities accounting has a unique purpose in managing it. These are individual accounts, mainly dedicated to tracking different types of accrued expenses.
A. Accounts Payable
This is an account that has the total amount owed to vendors for the services received on credit. It only includes the expenses for which we have received invoices. The difference with the accrued expenses account is that it captures the entire liability for unpaid expenses, even when invoices have not been provided.
B. Accrued Expense Accounts
The different types of accrued payable journal entries include:
-
Accrued Salaries
This account records unpaid wages earned by employees.
-
Accrued Interest
It tracks accrued interest on loans and debts of different kinds.
-
Accrued Utilities
The utility account represents the cost of utilities used but not billed.
-
Accrued Rent
Reflects accrued rent for occupying a property before the due date.
-
Accrued Taxes Payable
This tracks different taxes levied but unpaid, like income or property tax.
-
Accrued Professional Fees
Captures fees paid to professionals like lawyers or consultants for services taken before receiving an invoice.
C. Liabilities
Accrued liabilities accounting differs for each case. Accrued expenses are recorded in liability accounts depending on the nature.
-
Accrued Bonus Payable
In scenarios where employees earn bonuses which are paid later on. The entry is made on a separate bonus account.
-
Accrued Warranty Payable
Warranties offered on products that estimate liability for future claims are recorded in such an account.
Also Read: What Are Accrued Liabilities Payable?
Fundamentals of Debits and Credits
Before understanding the fundamentals of debits and credits of accrual accounting, it is essential to be aware of the basics of debiting and crediting. For instance, asset and expense accounts increase when debited and decrease when credited.
On the other hand, the owner’s liabilities and revenue accounts decrease when debited and increase when credited. The following table reflects the specificity of debit and credit in general:
| Types of Accounts | Debit | Credit |
| Assets | Increase | Decrease |
| Expenses | Increase | Decrease |
| Equity of Owner | Decrease | Increase |
| Liabilities | Decrease | Increase |
| Revenue | Decrease | Increase |
The principles involved in debit and credit of recording accrued expenses and paying the accrued expenses are:
1. Debit
The expense account is debited to see the cost incurred before the cash has been paid. Here, the expenses are matched with the revenue generated due to it. This procedure remains the same regardless of the payment timing.
In paying these expenses, they settle the liability by debiting the accrued expense account again when the payment is made. This reduces the amount owed.
2. Credit
The accrued expense account is credited to represent the liability created for the non-paid expense. This account reflects the amount owed to different vendors.
To pay the accrued expenses, we credit the cash account to reflect the cash outflow made for the payment.
Also Read: A Comprehensive Analysis Of Debit And Credit Notes And Their Importance
Accrual Accounting vs. Cash Accounting
A technique for recording income and costs depends on when cash is actually received or disbursed. This is called cash accounting. Cash accounting considers the movement of cash, as opposed to accrual accounting, which records income as it is earned and expenses as they are incurred.
The cash method records revenue and expenses when the cash is received or paid. The cash method would not record revenue until the consumer actually paid for the product. You can record a debit from its cash account and a credit to revenue. This method is simple and easy to understand. Since only cash flows are tracked, less record-keeping is required. But it provides a clear picture of the cash flow.
Accrual vs. cash accounting methods can have their own set of advantages and drawbacks; these are:
| Accrual Accounting Method | Cash Accounting Method |
| Records expenses when they are incurred do not depend on when payment is made. | Records expenses only when cash is paid out. |
| Records income when it is earned does not depend on when payment is received. | Records income only when cash is received. |
| Provides a complete picture of the company’s financial health as it considers both earned and incurred amounts, not just cash flow. | Provides a more straightforward approach, which makes it easier for smaller businesses to manage their records/ |
| Preferred by larger businesses and publicly traded companies because of its complex requirements. | Preferred by small businesses and sole owners because of its simplicity. |
Also Read: Understanding Accrual Accounts Payable
Accrued Expense: Debit or Credit?
As a liability account, an accrued expense has a natural credit balance. The adjusting journal entry debits the related expense account and credits the accrued expense account. The credit balance at month or year’s end is what flows through to the company’s balance sheet.
Accrued expenses have a dual nature because they are initially debited as expenses when they represent costs incurred. However, they are also credited with reflecting the corresponding liability. This nature highlights their role in accurately capturing both the expense and the obligation associated with it. This makes it difficult to decide whether accrued expenses are strictly debit or credit.
An expense recorded as incurred but not yet paid is referred to as an accrued expense, also known as an accrued debt. In most cases, an accrued expense is a debit to an expense account. This increases your expenses.
Understanding the role of debits and credits around accrued expenses is vital for accurate financial record-keeping. It is not just about identifying whether it is a debit or credit but understanding the accounting principles and their contribution to your business’s financial health.
Conclusion
Accrued expenses are healthy ways of recording finances. It is an integral part of reporting in business. There can be challenges in the proper implementation of its benefits. However, with the right knowledge, you can make better decisions for your business.
Utilising accrued expenses has a favourable impact on the business. This article explains the number of options that accompany the use of these. It could be rent, utilities, salaries, or interest accrued on a loan. While the invoice might not arrive, recognising the expense is essential to accurately match costs with the period incurred. Thus reflecting a more accurate picture of a company’s financial performance.
It is essential to understand that financial reporting is a complex process. Proper use of your knowledge and professional guidance must be used.
Frequently Asked Questions
-
What is the Importance of Accrued Expenses?
Accrued expenses are substantial because they help with cash flow management. Tracking these can help you consider upcoming payments and manage cash flow effectively. Thus, it helps to have an accurate financial picture. It also helps to identify financial issues and be aware of the financial health of your expenses.
-
What are Some Examples of Accrued Expenses?
Some common examples of accrued expenses are salaries and wages earned by employees in a pay period before they are paid. It includes interests, utilities, rent, and taxes. Professional fees rendered by professionals like lawyers or consultants before the invoice are also included.
-
How can Accrued Expenses be Recorded?
Accrued payable journal entries involve debiting an expense account and crediting a liabilities account. The accrued liabilities account is debited when payment is made, and the cash account is credited.
-
What is the Difference Between Accrued Expenses and Accounts Payable?
Accrued expenses include broader categories of unpaid expenses. Accounts payable are specifically for amounts owed to suppliers for goods or services received. Both are important for accurate financial reporting and for managing your cash flow. Accrued expenses help match expenses, while accounts payable records your immediate payment obligations.
-
How can Accrued Expenses be Estimated?
Accrued expenses can be calculated using partial bills, usage rates, and industry averages. Effective ways to estimate accrued expenses include gathering historical data and calculating per-unit costs. It should be understood that accuracy is vital. Aim for methods that provide reasonable and reliable figures to represent your actual financial obligations.
-
Can Accrued Expenses be Negative?
Accrued expenses are rarely negative. But it is possible to make advance payments or prepayments for delivered services. They represent an outstanding obligation to pay for goods or services already received so that a negative value wouldn’t make logical sense.
-
How can Accrued Expenses be Handled at the end of an Accounting Period?
During the completion of an accounting period, you can adjust the accrued expense accounts to reflect the actual amount owed. This involves additional calculations or estimations based on updated information.
-
What are the Tax Requirements for Accrued Expenses?
Accrued expenses are deduced in the period they are incurred. Irrespective of when they are paid. However, specific tax rules and timing considerations apply depending on your location and business type. Tax laws fluctuate, so staying informed and consulting professional guidance for further assistance is important.
-
Do you need Special Software to Track Accrued Expenses?
While not important, accounting software can simplify tracking and managing accrued expenses, especially for complex businesses. Spreadsheets can also be used for smaller businesses.
-
What should be done in case of a specific industry or situation related to accrued expenses?
It is best to consult with a professional accountant or tax advisor for specific guidance related to your industry and business size. They can help you handle accrued expenses accurately and comply with regulations.
