The accrual concept is an accounting principle that focuses on recording transactions when they occur rather than when cash is received or paid. It recognizes revenue when qualified as earned and expenses when incurred, regardless of the timing of cash flows. It ensures that financial statements provide a more accurate view of a company’s financial performance and position.
A typical liability under the accrual concept in accounting is accrued expenses. The name may suggest they are expenses. However, they represent liabilities. Before discussing the accounting implication for these, it is crucial to define accrued expenses.
What are Accrued Expenses?
Accrued expenses, also known as accrued liabilities or accrued liabilities, are an essential aspect of accounting that reflects the recognition of expenses incurred but not yet paid by a company. They represent the financial obligations owed for goods or services received but not settled. Various accrued expenses exist, including salaries and wages, utilities, interest, taxes, and rent.
Accrued expenses increase the company’s liabilities and related expenses, reflecting the commitment to pay the accrued amounts in the future. Once they get settled, the obligation decreases, and the corresponding cash outflow gets recorded. Accrued expenses are crucial in providing an accurate financial snapshot of a company’s obligations and the timing of expenses, contributing to transparent financial reporting and management.
What is the accounting treatment for Accrued Expenses?
The accounting treatment for accrued expenses involves recognizing the charge and creating a corresponding liability. Firstly, the expense gets recognized by recording it in the appropriate expense account, such as salaries, utilities, or interest. Simultaneously, the company creates an obligation to represent the amount owed, recorded as an accrued expense liability account.
When the company settles the accrued expense and reduces the liability, it records the corresponding cash outflow. The payment is typically debited to the accrued expense liability account and credited to the cash or bank account. This accounting process ensures that accrued expenses are recognized, and liabilities get reported accurately.
What is the journal entry for Accrued Expenses?
Accrued expenses get recorded in two stages. First, when an expense occurs with no settlement at the date, the company records an increase in liabilities. Companies can do so using the following journal entry.
| Dr | Expense account (salaries, utilities, etc.) |
| Cr | Accrued Expenses |
Once the company settles the liability, it must remove it from the accrued expenses account. Usually, the settlement occurs through cash or a bank account. Therefore, the journal entry may be as follows.
| Dr | Accrued Expenses |
| Cr | Cash or bank |
Example
A company, Red Co., pays its employees salaries and wages on the 5th of each month. Every month, the company accrues $20,000 in payable salaries and wages. The company records the liability at the end of each month as an accrued expense as follows.
| Dr | Salaries and wages | $20,000 |
| Cr | Accrued Expenses | $20,000 |
When Red Co. pays its employees on the 5th of the month, it removes that liability from the accrued expenses account. Usually, the settlement occurs through the company’s bank account. Red Co. uses the following journal entry to record the transaction.
| Dr | Accrued Expenses | $20,000 |
| Cr | Bank | $20,000 |
Conclusion
Accrued expenses represent a liability incurred for expenses where a settlement has not occurred. This liability is a requirement under the accrual concept in accounting. Usually, companies account for accrued expenses in two stages. Recording these expenses is crucial in presenting a company’s financial position accurately.
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