What are Accrued Expenses?
An accrued expense is an expense that has been incurred, but for which there is not yet any expenditure documentation. In place of the documentation, a journal entry is created to record an accrued expense, as well as an offsetting liability. In the absence of a journal entry, the expense would not appear at all in the entity’s financial statements in the period incurred, which would result in reported profits being too high in that period. In short, accrued expenses are recorded to increase the accuracy of the financial statements, so that expenses are more closely aligned with those revenues with which they are associated.
The journal entry is normally created as an automatically reversing entry, so that the accounting software automatically creates an offsetting entry as of the beginning of the following month. Then, when the supplier eventually submits an invoice to the entity, it cancels out the reversed entry.
Types of accrued expenses
There are several types of accrued expenses that a company may record in its financial statements. Salary and wages payable, interest and other expenses like loan interest or taxes can all be considered accrued expenses.
1. salaries and wages payable:
Salaries and wages payable refers to the account that records the income that employees are owed for their work. Salaries refers to salaried employees, who make the same amount per payroll period regardless of time worked. Wages refers to hourly employees, whose payroll amount is dependent on hours worked. The payable salary period may follow a weekly, bi-weekly, monthly or bi-monthly schedule. Oftentimes, an organization’s pay period may end before the accounting period, meaning an organization must account for the future pay in the current accounting period.
So when a company tracks expenses in their financial records, the salary that is expected to be paid to the employee after the accounting period should be recorded as an accrued expense.
2. interest payable
Interest payable refers to any interest expenses (like interest on a loan) that a company has incurred but has not yet paid off. The accrual entry is recorded at the end of the accounting period based on how much interest has actually been accumulated on the loan.
3. Other expenses
Other expenses—like utilities or taxes—are also usually accrued, since you incur the debt earlier than you will receive the invoice (utilities) or will make the payment (quarterly taxes for businesses).
Advantages of Accrued Expenses
- It helps in establishing the real financial position of the company.
- As and when transactions are conducted, it gets recorded in the accounts, which makes it less prone to errors.
- It is a more accurate basis of recording transactions as it is based on the double entry system of accounting.
Disadvantage of Accrued Expenses
- It becomes difficult for accountants to maintain track of the number of transactions taking place in a large business organisation