Accrued expenses are payments that a company is obligated to pay in the future for goods and services that were already delivered Simply put, a business receives a good or service and pays for it. Although it is accounted for, this charge is paid after. When a corporation accrues expenses, it signifies that its unpaid bills are growing because the word accumulated means to increase or accumulate. Under the accrual method of accounting, costs are recorded when they are incurred, not necessarily when they are paid.
Presentation of Accrued Expenses
Most accumulated expenses are anticipated to be paid for in a very short period, such as the following month. The liability for an accrued expense is shown in the balance sheet as a current liability when the settlement term is within the following year. The liability is categorized as a long-term liability in place of a short-term liability if the anticipated settlement date is more than a year away.
Accounting for Accrued Expenses
Accrued expenses are financial obligations incurred but not yet paid. Here are examples of when to record them:
- Office supplies received with no invoice by month-end: Debit office supplies expense, credit accrued expenses.
- Employee hours worked but unpaid by month-end: Debit wages expense, credit accrued expenses.
- Benefit liability incurred with no invoice by month-end: Debit employee benefits expense, credit accrued expenses.
- Accrue income taxes based on earned income: Debit income tax expense, credit accrued expenses.
- It brings financial processes into closer alignment with those of the business itself.
- Frequently improves the consistency of monthly financial statements
- May provide management with more valuable information to make decisions or plans.
- Complies with the criteria for external financial reporting
- When compared to the cash method of accounting, preparation frequently takes more time and resources.
- Typically leads to a higher risk of misrepresentation (accruals not reversing or accidental duplication)
- May complicate some reporting by blurring cash usage and capital needs
Practical Application of Accrued Expenses
Realistically, the amount of an expense accrual is only an estimate, and so is likely to be somewhat different from the amount of the supplier invoice that arrives later. As a result, the next month typically sees a minor increase in expense or a decrease in expense recognition once the journal entry reversal and the amount of the supplier invoice are netted against each other.
Practically, immaterial expenses are not accrued since it would take too much time to prepare and record the corresponding journal entries. Additionally, a lot of journal entries for accrued expenses will make the month-end closing process take longer.