Journal Entry For Accrued Expenses

Accrued expense refers to the expense that has already been incurred but for which the payment is not made. This term comes into play when in place of the expense documentation, a journal entry is made to recognize an accrued expense in the income statement along with a corresponding liability that is generally categorized as a current liability in the balance sheet.

  • If the journal entry is not created, then the expense will not appear in the financial statements of the companyFinancial Statements Of The CompanyFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more in the period of occurrence, which will result in a higher reported profit in that period.In short, this journal entry recognized in the financial statements enhances the accuracy of the statements. The expense matches the revenue with which it is associated.

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Example of Accrued Expense Journal Entry

A company, XYZ Ltd, has paid interest on the outstanding term loan of $1,000,000 for March 2018 on 5th April 2018. The interest is charged at 1% per month. Determine the accrued expense journal entry for the example transaction, given that XYZ Ltd reported the accounting year at the end of 31st March 2018.

As per the matching conceptMatching ConceptThe Matching Principle of Accounting provides accounting guidance, stating that all expenses should be recognized in the income statement of the period in which the revenue related to that expense is earned. This means that, regardless of when the actual transaction is made, the expenses that are entered into the debit side of the accounts should have a corresponding credit entry in the same period.read more, XYZ Ltd will record the interest expenseRecord The Interest ExpenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more  of $10,000 (= 1% * $1,000,000) in the financial statements of the financial year ending on 31st March 2018, even though the interest was paid in the next accounting period, because it is related to the period ending on 31st March 2018.

The following accounting entry will be recorded to account for the interest expense accrued:

The accounting entry will be reversedEntry Will Be ReversedReversing entries refer to those journal entries passed in the current accounting period to offset the entries for outstanding expenses and accrued income recorded in the immediately preceding accounting period.read more on the day of payment of the interest, i.e., 5th April 2018, and the following accounting entry will be recorded in the subsequent financial year:

Advantages

  • The primary advantage is the accurate representation of the company’s profit, which otherwise will be overstated.Under accrual accounting, liabilities become more transparent. Given that the financial transactions are recorded immediately as it occurs, the chances of discrepancies or errors are almost zero. Also, the information remains easily accessible for audits or similar activities because all the transactions are recorded.Another advantage is that the users of the financial statementUsers Of The Financial StatementFinancial statements prepared by the Companies are used by different categories of individuals and corporates on the basis of their relevancy to the respective parties. The most common users to the financial statements are Management of the Company, Investors, Customers, Competitors, Government and Government Agencies, Employees, Investment Analysts, Lenders, Rating Agency and Suppliers.read more can see all the obligations of the business along with the dates on which it will become due. Under the cash basis of accountingCash Basis Of AccountingCash Basis Accounting is an accounting method in which all the company’s revenues are accounted for only when there is an actual cash receipt, and all the expenses are recognized when they are paid. Small companies and individuals generally follow this accounting method.read more, the full extent of such transactions is not entirely clear.Unlike cash accounting, accounting of accrued expense journal entries is based on the double-entry systemThe Double-entry SystemDouble Entry Accounting System is an accounting approach which states that each & every business transaction is recorded in at least 2 accounts, i.e., a Debit & a Credit. Furthermore, the number of transactions entered as the debits must be equivalent to that of the credits. read more. It means that while one account debits, another account credits. A financial user can see that one account decreases while the other one increases. It enhances the accuracy of the accounting system, which makes things easier during audits.Another benefit is that GAAP recognizes accrual accounting, and as such, many companies follow the practice of recording accrued expenses.

Essential Points to Note about Accrued Expense Journal Entry

A company usually recognizes an increase in accrued expenses immediately as it occurs. It is credited to accrued expenses on the liability side of the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more. The increase in accrued expense is complemented by an increase in the corresponding expense account in the income statement. Hence, the company will debit the expense account and insert it as an expense line item in the income statement. Therefore, an increase in accrued expense has a reducing effect on the income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more.

On the other hand, a decrease in accrued expenses happens when a company pays down its outstanding accounts payableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more on a later date. To recognize a decrease in accrued expenses, a company will debitDebitDebit represents either an increase in a company’s expenses or a decline in its revenue. read more the accounts payable to decrease the accounts payable on the liability side and credit the cash account on the asset side by the same amount. It is to be noted that the cash paid in the current period is not an expense for this period because the related expense has happened and was subsequently recorded in the previous accounting period. Therefore, a decrease in accrued expensesAccrued ExpensesAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited.read more does not affect the income statement.

Conclusion

Although accrued expense is not paid in the same period when it occurs, it is captured in the balance sheet for the period. It is crucial from an accountant’s point of view as it helps him maintain a transparent accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company’s performance and ensuring the smooth operation of the firm.read more in concurrence with the matching principle. Also, from an investor’s perspective, accrued expense helps ascertain an accurate picture of the company’s profit.

This article has been a guide to Accrued Expense Journal Entry and its meaning. Here we discuss Accrued Expense Journal Entry examples along with advantages & disadvantages. You can learn more about accounting from the following articles –

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