The term “accrued” means “accumulate” or “increase”. As such accrued liabilities mean that the unpaid bills issued to the company are increasing. When the expenses are made by customers, they don’t make cash payments every time.
Despite payments being not made, the company records such expenses as accrued expenses in their books of accounts. Such expenses are accounted for when they occur.
They are recorded as the liabilities of the company. Hence, they may be also called accrued or outstanding liabilities.
Having a grasp on the firm’s accrued liabilities helps in maintaining a healthy cash flow to the company.
What is Accrued Expense?
An accrued expense is a concept in accrual accounting where expenses are recorded in the books of accounts irrespective of payments being made. Typical accrued expenses include salaries, wages, goods, and services consumed but prices not paid for them.
They are generally recorded as current liabilities since they generally get paid within a year from the date of incurring. They accrue in the accounts payable account which is shown on the balance sheet. They are recorded to increase the accuracy of the financial statements.
Nature of accrued expense account:
Accrued expenses or outstanding expenses are treated as personal accounts. In fact, they are representative personal accounts since they don’t represent natural persons. Instead, they represent the outstanding expenses to a group of people.
Presentation in the financial statements:
Accrued expenses are generally shown as current liabilities in the balance sheet and accrued expenses are added to the concerned expenses account in the income statement.
At the end of each accounting period, a company should estimate the accrued expense and record it as an accrued expense with an equally payable account.
At the start of the next accounting period, the entry will be reversed. This implies that the expense shifts to the next accounting period.
The format of the accrued expense journal entry is given below:
Examples of accrued expenses are given below:
- Interest on loans for which invoice hasn’t been raised by the lender
- Goods received and sold but supplier invoice not yet received
- Wages or salaries incurred but payment not made yet
- Taxes incurred but no government invoice received yet
Recording accrued expenses:
Let us understand the concept of accrued expenses with an example:
An Ltd. pays the interest of USD 45000 of December 2019 on January 5, 2020. An Ltd. follows the accounting year ending on 31st December.
Now, A Ltd. will recognize the interest expense of December in December itself i.e., on 31st December 2019 itself despite payment being made on January 5, 2020. Following accounting entry will be made to record the transaction:
On 31st December, the following entry will be recorded:
|Interest expense||xxx, xxx|
|Interest Payable||xxx, xxx|
The expenses account has been debited total income is reduced irrespective of the payment of expenses. Accrued expenses increase the current liability, so accrued expenses are credited.
Interest payable is added to the interest expense in the income statement of the year ended 31st December 2019.
Interest payable will be shown on the liability side of the balance sheet. If the interest will be paid within a year, it is treated as a current liability and if it is to be paid in more than a year, it is treated as a non-current liability.
On January 5, 2020, the following entry will be passed:
|Interest payable||xx, xxx|
|Cash or bank||xx, xxx|
Accrued expenses can be recorded by debiting the concerned expenses account and crediting the accrued expense account for recognizing the accrued expense liability.
Advantages of recording accrued expense:
- It helps in the preparation and presentation of financial statements which give a true and fair view.
- It helps in the correct statement of the company’s profits.
- This recording of accrual expenses reduces the chances of mistakes or errors.
- Liabilities get more transparent and are easily accessible for the auditors.
- It helps the owners to better understand the financial position of the enterprise.
Let us see the balance sheet with the different items and try to understand the presentation of accrued expenses:
Balance Sheet “Liabilities” excerpt
|Total current liabilities||25,000|
In the above example, everything is an example of accrued expense. Often accrued expenses are estimated.
An accrued expense is always credited unless it is canceled by the payment of expenses or settlement of accrued expenses.