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 price 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:
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:
Cash or bank
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 about the presentation of accrued expenses:
Balance Sheet “Liabilities” excerpt
Total current liabilities
In the above example, everything is 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.
Do customers pay for the goods or services purchased before delivering them? The answer is big YES. If so, the need for knowing about deferred revenue arises. In common parlance, it is called unearned revenue.
The revenue becomes unearned when the company receives advance payment for a product/service which has not been delivered yet.
Receiving a payment is generally considered as an asset but prepayments are liabilities as they have not been earned yet and business still owes the delivery of product or service to the customer.
It is shown on the liabilities side of the balance sheet. But the deferred revenue turns into earned revenue only after the receipt of goods or services by the customers.
What is deferred revenue?
It is the cash or cheque payment made by the customers for the goods or services which haven’t been delivered to them yet. Deferred revenue is common in subscription-based revenue service providers.
For instance, the big houses like Netflix, Amazon Prime Video recognizes the subscription revenue on a deferred basis. It may be sometimes recognized as Unearned revenue, Deferred Income or Unearned Income.
The deferred revenue starts getting realized into revenue as the goods or services get delivered to the customers. Deferred revenue is recorded due to the use of accrual and matching system of accounting by the business firms.
The accounting for the deferred arises due to the accrual system of accounting and accounting standards on revenue recognition.
Briefly speaking as per Accrual system of accounting, financial transactions are recorded as and when they occur. The accounting standard AS 9 on revenue recognition provides criteria for recording revenue as follows:
The company must have delivered the products or provided the services in full before recognizing the revenue. Else it can only estimate and book the revenue for the part delivered.
The company must be certain that it will be able to collect the revenue
The price of the goods or services are fixed or can be determined easily.
Since the above conditions are not fulfilled in case of prepayments made before receipt of goods or services, revenue is not recognized in full and it is recognized periodically as and when the revenue becomes due.
IFRS 15 on Revenue Recognition states that” recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”
Recording deferred revenue
As the goods or services are delivered over some time, it is gradually recognized as revenue in the income statement over a period when the revenue gets earned at given intervals of time.
The proportionate earned revenue is recorded as earned revenue in the income statement and the remaining portion of revenue is recorded as deferred revenue in the liability side of the balance sheet.
Examples of such revenue are advance rent payments, prepaid subscription fees of newspapers, streaming services or prepaid insurance.
The entries to record such revenue are as follows:
When cash is received:
(To record the receipt)
At the end of each month:
(To record revenue recognition)
Let us understand the process of recording deferred revenue with an example:
Netflix provides a 1-year subscription package at $ 3000. The customer opts for a yearly package. Upon receipt of the payment of 1year from the customer, Netflix debits entry to cash and credits entry to deferred revenue of $3000.
As the months go on passing, the company recognizes the revenue of $250 each month by debiting deferred revenue account and crediting revenue account. By the end of the year, the whole balance of deferred revenue is reduced to 0 and the revenue account gets increasing by the concerned realized revenue. This can be recorded as follows:
At the beginning,
(To record the receipt)
At the end of each month:
(To record revenue recognition)
Finally, the whole revenue would be recognized as revenue at the end of the year and will be recorded as:
(To record revenue recognition)
The amount of $3000 would be recorded as revenue in the income statement under Subscription Revenue. The adjusting entry would be:
Profit & loss account
(To record transfer of revenue to P/L Statement)
The concept of deferred revenue arises prominently in the construction contracts where revenue is recognized based on the percentage of completion of work. Under this method, the Company recognizes revenue as certain milestones are met.
Assets are resources owned or controlled by a company or business that bring future economic inflows. There are various types of assets that companies use in daily operations to generate revenues. Among these are fixed assets, which they use in the long run to generate revenues. These assets can be either tangible or intangible.
What is the Amortization Expenses?
Amortization, in accounting, refers to the technique used by companies to lower the carrying value of either an intangible asset. Amortization is similar to depreciation as companies use it to decrease their book value or spread it out over a period of time. Amortization, therefore, helps companies comply with the matching principle in accounting.
Sometimes, amortization also refers to the reduction in the value of a loan. In this case, amortization is similar to its use for assets. Companies use amortization to spread out a loan over time.
To do so, companies may use amortization schedules that lenders, such as financial institutions, provide to the borrower, the company, based on the maturity date. The schedule will consist of both interest and principal elements for the company to record.
Overall, companies use amortization to write down the balance of intangible assets and loans. Similarly, it allows them to spread out those balances over a period of time, allowing for revenues to match the related expense.
For intangible assets, companies use the useful life of the asset to divide its cost over time while for loans, they use to number of periods for payments.
The journal entry for amortization differs based on whether companies are considering an intangible asset or a loan.
For companies to record amortization expense, it is necessary to have some specific amounts. Firstly, companies must have the cost of the asset or its carrying value, recognized based on the related standards.
Similarly, they need to establish a useful life for the intangible asset based on judgment. After that, companies will need to decide on the method of amortization, similar to depreciation, either straight-line or reducing balance method.
After calculating the amortization for the intangible asset based on the method used, companies can record the expense using the following journal entry.
The accounting treatment for the amortization of intangible assets is similar to depreciation for tangible assets. The amortization expense increases the overall expenses of the company for the accounting period. On the other hand, the accumulated amortization results in a decrease in the value of the intangible asset in the Balance Sheet.
As stated above, most financial institutions provide companies with loan repayment schedules with the breakup of periodic payments split into principal and interest payments.
Companies can use the schedules to determine the value they should record. However, they can also calculate the value based on the agreement made with the related financial institution.
Once companies determine the values of both the principal and interest payment, they can use the following journal entry to record amortization expense for loans.
The interest expense here results in an increase in the overall expenses of a company in the Income Statement. The debit to the loan account, with the principal value, reduces the value of the loan in the Balance Sheet.
Lastly, the credit to the cash or bank account is the amount of repayment made by the company. It decreases the cash balances of the company in the Balance Sheet.
A company, ABC Co., purchased an intangible asset of $10,000. It recorded the asset in its accounts at its cost. ABC Co. also determined the useful life of the intangible asset to be five years. The company uses a straight-line amortization method.
At the end of the year, ABC Co. must record the amortization expense for the asset. The amortization expense for the asset will be $2,000 ($10,000 / 5 years) each year.
To record the amortization expense, ABC Co. uses the following double entry.
ABC Co.’s expenses in its Income Statement will increase by $2,000. At the same time, its Balance Sheet will report an intangible asset of $8,000 ($10,000 – $2,000).
Amortization is a technique used in accounting to spread the cost of an intangible asset or a loan over a period. In the case of intangible assets, it is similar to depreciation for tangible assets.
For loans, it helps companies reduce the loan amount with each payment. The accounting treatment for amortization is straightforward, as stated above.
The need for journal entry testing arises when the auditor needs to test the nature, timing, and extent of journal entries. It is done to recognize the risk of material misstatement due to fraud while recording financial transactions.
The auditor should be vigil in its audit of transactions and should look at all the transactions of suspicious nature. The auditor should verify all the transactions with the supporting documents and all the entries should be duly authorized by higher authority after accountant records the transactions.
During audit, the auditor usually tests the sample transactions by following substantive procedures. He verifies the authenticity, validity, accuracy of the transactions.
During this procedure he may cross check the journal entries with the supporting documents, vouchers. Journal entry testing is carried out to have a proper understanding of the internal control system of the company.
This testing also reflects on the compliance procedures adopted by the company in dealing with the established rules and standards of accounting and auditing.
Journal entries are prepared by the accountants so this testing should involve the inquiries of management and other staffs including the internal auditors about the risks of fraud. Journal entry testing is carried out by the auditors who audit the financial transactions of the company.
Else the testing can be done for external requirements when a court or government orders a probe into the financial transactions of the company due to financial misconduct, fraud, and negligence.
Importance of Journal Entry Testing:
Data analysis in audits: Audit testing is carried out to gather sufficient and appropriate audit evidence. Without testing journal entries, the professional requirement for documentation and test of efficiency and effectiveness of the internal control system cannot be carried out. Data analysis has become a wide field to recognize the trend and is necessary for the success of the enterprise.
Maintains quality and efficiency: The volume of data used in companies is increasing manifold. These transactions are recorded in accounting packages. Hence it helps to increase the authenticity, validity, and accuracy of the transactions. The journal entry testing ensures that all the postings are done in line with standards set by the organization and following all the audit and accounting standards.
Detects misstatements including fraud: This testing is done on sample entries and if any suspicion arises on such entries, the auditor goes through extensive audit procedures viz. compliance and substantive procedures to detect misstatements and frauds. The frauds when detected during journal entries testing mean that auditors need to expand their audit sample and, in some cases, extend to the whole of the population.
Test the appropriateness of the entries made: This testing is carried out to know whether the entries are authorized by the higher authority and the proper backing of such entries is available.
Test the existence, working of internal control system: Journal entry testing helps in detecting the existence, the efficiency of the internal control system. When the internal control system is functioning properly, the frauds cannot go unnoticed and it can be detected by maker and checker policy. Maker and checker policy basically mean a dual way of preparation of any accounting records and verification of the same by another accounting staff preferably of higher authority and qualification.
Used as evidence during forensic audits: When forensic audits are carried out to unearth the frauds in a company, journal entry testing can be used as evidence by the investigating agencies in trial proceedings. When it has been established in the journal entry testing that internal controls have been good, forensic audits can be conducted thoroughly and effectively and in line with guidance.
Helps to detect the inappropriate financial assertions: Financial assertions include completeness, cut-off, accuracy, occurrence, and classification. So, the recorded expense transactions should pass the above tests. When any lapses occur in relation to the above criteria, journal entry testing can trace those errors. The accountants may make mistakes as a result of ignorance or due to low knowledge of such aspects. Hence, the journal testing would help to remove such assertions but after the entries have been made.
Protects the company and its stakeholders from impacts of fraud: This testing helps to detect the lacunae in the internal control system and frauds in the accounting of the financial transactions. If frauds are detected at an early stage, the reputation of the company still remains intact. How it deals with these circumstances also ensures the survival and brand reputation of the organization.
In accounting, journal entries are to a big extent one of the most significant abilities to ace. Without legitimate journal entries, organizations’ financial reports would be wrong and a total wreck. If you do not want to risk your accounting career, then read the importance and method of entry testing below.
Understanding Journal Entries
A simple method to comprehend journal entries is to consider Isaac Newton’s third law of motion, which expresses that for each activity there is an equivalent and inverse response. In this way, at whatever point a transaction happens inside an organization, there must be in any event two accounts influenced.
For instance, if an organization purchased a vehicle, the organization’s assets would go up by the estimation of the vehicle. In any case, there should be an extra account that changes (i.e., the equivalent and inverse response).
The other account that is influenced is the organization’s money going down in light of the fact that they utilized the money to buy the vehicle.
At long last, much the same as how the size of the powers on the primary object must be equal to that of the subsequent item, the charges and credits of each journal entry must be equivalent.
A journal is the organization’s legitimate book wherein all transactions are recorded in sequential order. Even though numerous organizations use account programming these days to book journal entries, journals were the dominating technique for booking previously.
In each journal entry that is recorded, the charges and attributes must be equivalent to guarantee that the bookkeeping equation (Assets = Liabilities + Shareholders’ Equity) stays inequality. While doing journal entries, we should consistently think about four variables:
Which accounts are influenced by the money exchanges
For each account, decide whether it is expanded or diminished
For each account, decide the amount it is changed
Ensure that the bookkeeping equation remains in balance
The most ideal approach to ace journal entries is through training. Here are various examples that outline some normal journal entries. The primary example is a finished walkthrough of the cycle.
Examples of journal entries
Example 1 – Buying the inventory journal entry
Bought stock costing $15,000 for $5,000 in cash and the remaining $80,000 is recorded in the record
CR Accounts Payable
Example 2 – Getting land journal entry
Bought land costing of $60,000 and buildings for $400,000. Gave $100,000 in cash and marked a note payable for the equalization.
CR Note payable
Method to Track Journal Entries
A huge part of accounting includes monetary reporting. Financial reporting is the demonstration of introducing an organization’s financial summaries to the board, management, the government, and different clients to assist them with settling on better money related choices.
So as to decide the last money related estimation of accounts that are recorded on the financial summaries on the organization’s year-end, various journal entries are recorded and followed in an account known as a T-account, which is a visual portrayal of the general ledger account.
The suitable charges and credits are recorded under the fitting sections under these T-Accounts to decide the last incentive to be accounted for.
Why are journal entries important to careers in accounting?
Despite the fact that recording journal entries can be exceptionally tedious and dull, recording precise entries at the perfect time is basic for organizations to show their right budgetary status to individuals inside the firm as well as to outer clients and users.
With incorrect entries, organizations might be seen to have more obligation or less obligation or as more productive or less gainful than they really are. Thus, this could lead organizations and financial specialists to settle on choices dependent on bogus, deceiving data, prompting negative consequences.
Having what it takes to record and comprehend journal entries is fundamental in any vocation in Accounting, regardless of whether you are associated with public practice and are taking a shot at a customer’s audit file, or you are working in an industry and assisting with setting up an organization’s fiscal statements.
In basic terms, the initial step to appropriate financial reporting vigorously depends on recording precise journal entries.
Following the method explained in this article will be very advantageous for your accounting career. This is because recording journal entries is a skill that should be practiced and understood by everyone in the field.
To understand what a recurring journal entry is, it is necessary to discern the theory of journal entries. Journal entries are the initial influx of business transactions in their books.
A journal entry has a dual-sided effect that amends figures in two distinct accounting heads in books of business.
It is imported in the general ledger which is then used to prepare financial statements of the company. Journal entry is, therefore, the foundation of the Company’s financial statements.
Recurring journal entries are associated with transactions of expense, income, cash, or non-cash transactions that appear periodically every month, quarter or year.
These are typically used to record the most usual transactions that occur every period. Some illustrations which explain the notion of recurring journal entries are depreciation that is integrated once in a year debits the depreciation expense and credits the accumulated depreciation which in turn diminishes the value of the asset, hence a dual effect.
Insurance premiums which are paid monthly, quarterly or even annually, debit the insurance expense account while credits the corresponding cash or payable account, again a dual projection on books of the organization.
does Recurring Journal Entries work?
Companies implant the effect of recurring journal entries over a proper carrier to correctly record its fallout. Organizations need to decide about the journal entries to automate in their books.
These journal entries can be automated in cloud accounting systems, computerized processes or manual accounting systems of the organization. When businesses develop a transaction which they feel should be projected in every period, is infused through the system.
This process of placing of journal entry will repeat itself in every applicable period. As the business has to implement the effect of every journal entry, this automation will hit the dual accounting heads every period.
This effect will result in amending the general ledger figures at different places and therefore affecting the company’s financial statements.
account but different amount journal entries:
There are some occurrences in which the recurring journal entries alike have the same nature in every cycle, but cannot be mechanized because of the varying monetary amount.
These are the journal entries that need manual entry by bookkeepers to report them in business books. One case of this is the varying lease payments in which periodical payments such as principal and interest vary with time but its nature remains the same.
The types of recurring journal entries count on the nature of business. There are a few accounting heads that every business follows. Some of these journal entries comprise of depreciation, interest expense payments, loan principle repayments, etc.
Some journal entries are explicitly designed for the business for their intrinsic desire. These are recurring journal entries that are pursued by businesses because they are bound to do them.
One example of this is lease interest and principle payments which are assimilated only by businesses who have entered a lease deal.
Recurring journal entries are therefore followed by businesses to implement the same nature transactions in every period. These may or may not have the same monetary value but they must have the same nature.
As explained above, let’s say depreciation which occurs every period and hence the organization is bound to consider it in their books.