Accrued Expense Meaning

Understanding Accrued Expense

The Principal of Accrual AccountingPrincipal Of Accrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more requires that expenses be recorded as the firm incurs them irrespective of whether actual cash has been paid. Therefore, it helps in the proper measure of the performance of a business during a reporting period as it accounts for the expenses incurred (although not due to be paid) with the associated revenues of the reporting periodReporting PeriodA reporting period is a month, quarter, or year during which an organization’s financial statements are prepared for external use uniformly across a period of time in order for the general public and users to interpret and evaluate the financial statements.read more. Also, it helps avoid misstatement of the financial performance of the business. It enables various stakeholders to analyze the business to perform better and gain investors’ confidence as GAAPGAAPGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more compliant.

A most popular example of accrued expense includes Salaries payableSalaries PayableSalary payable refers to the liability of the company towards its employees against the amount of salary of a period that became due but has not been paid yet to them by the company and it is shown in the balance of the company under the head liability.read more as companies typically pay their employees at a later date for work done in the prior month.

Accrued Expenses on Balance Sheet

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These are the income due to the employees for the work done and are usually paid weekly or monthly. For instance, the work done by employees of Alex International is paid in the next month. Accordingly, it should be recorded by debiting Wages and Salaries Expenses, crediting Accrued Expenses, and making an offsetting entry by debiting these expenses and crediting cash when payment is made.

It refers to the interest expensesInterest ExpensesInterest 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 which have occurred but are not yet due to being paid by the business. An adjusting entry needs to be passed on recording the impact of such an accrued interest.

Let’s understand the same with the help of an example:

XYZ Company borrowed $100,000 on October 1, 2018, and requires making the complete repayment on January 31, 2019, along with interest of $5000. Therefore, as of December 31, 2018, it is not necessary for XYZ to make any interest expenses. However, $3750 ($5000*3/4) of Accrual expenses has occurred and will consist of debt of $3750 of interest expense and a credit of $3750 to the Interest Payable Account.

Other examples may include the following

  • Rent owed by the business but not yet paid.Commission and Royalties are yet to be paid by the business.Utilities and Taxes owed but not yet paid by the business.

Starbucks Accrued Expense

source: Starbucks SEC Filings

The list of accrued expenses in Starbucks is –

  • Accrued Compensation and Related CostsAccrued Occupancy CostsAccrued TaxesAccrued Dividends PayableDividends PayableDividend payable is that portion of accumulated profits that is declared to be paid as dividend by the company’s board of directors. Until the dividend declared is paid to the concerned shareholders, the amount is recorded as a dividend payable in the head current liability.read moreAccrued Capital and other Operating Expenditures

Examples of Accrued Expenses

Gluon Corporation operates in the Pharmaceutical Industry and pays a fixed 2% commission on Monthly Turnover payable on the 7th day of next month. The Company achieved a turnover of $40000 during the month ending December 31, 2018. However, the commission was payable on January 7, 2019, and as such, the following journal entries will be passed to record the Accrual commission of $800 ($40000*2%)

Matija Square has a five-day working week, and payday is Friday of each week. Therefore, weekly salaries are $5000. The current Accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company’s overall performance.read more ended on Thursday, December 31, 2015. Therefore, Matija Square will adjusting journal entriesAdjusting Journal EntriesAdjusting Entries in Journal is a journal entry made by a company at the end of any accounting period on the basis of the accrual concept of accounting. Companies are required to adjust the balances of their various ledger accounts at the end of the accounting period in order to meet the requirements of the various authorities’ standards.read more to account for the Wages accrued of $4000 ($5000*(4/5)).

Flour International utilized the services of an Electrician to repair the light fixtures in their retail shop on December 24, 2018, which resulted in an expense amounting to $300.The electrician sent the bill to Flour International on January 3, 2019. As a result, flour International will report the $300 expenses as Accrued Expenses on its 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 and will reduce the associated amount of $300 from its Income Statement on December 31, 2018; however, the actual payment will be made on January 3, 2019.

Changes in Accrued Expenses

Changes in Accrued Expenses should be closely monitored by those analyzing the business’s financials. An increasing trend in such expenses signifies that the business is not honoring the expenses. As such, the profit reported is overstated as there will be an increase in cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more and such increase in Accrued expenses to the extent to which they relate to the period must be adjusted from reported Profits to get a clear picture of the profit earned by the business in the period to which such expenses are associated.

Conclusion

Accrued Expenses are expenses incurred but not paid by the business during the accounting period. These expenses are reflected on the business’s balance sheet under short-term liabilities and should be monitored closely by those tracking the business. Its performance and changes in such expenses should be duly accounted for in the profit reported by the business.

This article has been a guide to Accrued Expenses and their meaning. Here we discuss examples of accrued expenses on the Balance Sheet and their types. You can learn more about accounting from the following articles –

  • How Accruals in Accounting Works?Accrued Income OverviewAccrued Revenue MeaningCash Accounting vs. Accrual Accounting – Compare