What are Accrued Expenses? – Definition
Accrued Expenses are the expenses that have been incurred, i.e. whose benefit or services have already been received, but which have not been paid for.
Accrued expenses are those expenses that have been incurred but have not been recorded, necessitating the adjustment entries and the inclusion of such items as interest expenses, salary expenses, and tax expenses.
Most businesses record expenses in their books of accounts only when they are paid. For example, the first accounting entry to record an electricity expense is made not when an electricity bill is received, but when it is paid. Thus in most cases, the balances on expense accounts like electricity, telephone, wages, etc., as shown in the year-end Trial Balance represent the amounts actually paid out during the year.
Now it is quite common that a bill may be received after the end of the year that relates to a service received before the year-end. The Trial Balance will, of course, have no record of the bill, and yet it would be wrong to ignore the expense involved when preparing the year’s Profit & Loss Account.
Accrued expenses include such items as interest expense, salaries tax expense, rental expense, or any other expense incurred in one accounting period that will be paid in subsequent periods. Adjusting entries must be made for these items in order to recognize the expense in the period in which it is incurred, even though the cash will not be paid until the following period. Like accrued revenues, the accrued expenses occur continuously, but in order to simplify the accounting process, they are recorded only at the end of the accounting period, by recognizing an accrued payable and a corresponding expense item.
Let us take the specific example of Mr. John, a wholesaler, who got a telephone installed in his shop on August 2019. He received the following bills:
Bills for August. received and paid in September: $750
Bill for September, received and paid in October: 840
Bill for October, received and paid in November: 910
Bill for November, received and paid in December: 960
The bill for December had not been received by 31 December 2019 when the ledger was balanced and a Trial Balance extracted. The Telephone Account, therefore, showed a Dr. balance of $3,460 (as above). After the Trail Balance had been drawn up, the December bill arrived. It was for $870. The situation, therefore, is that the Trial Balance states that Telephone expense for the year is $3,460: but in fact, the true telephone expense for the year is $4,330 ($3,460 + $870). Even though the December bill has not been recorded in the books, the fact is that the service has been received, and hence expenses incurred. Secondly, there also is the fact that though Mr. John’s Trial Balance doesn’t disclose it, on 31st December 2019 he owes $870 to the Telephone Company for the services that he has already consumed.
It follows therefore that Mr. John’s Trial Balance must be adjusted for two details:
a) To show that the actual Telephone Expense is greater than the amount shown in the Trial Balance, and
b) To show that there exists a liability on Mr. John’s part to pay the December bill, not disclosed by his Trial Balance.
Journal Entries to record Accrued Expenses
The accounting entry required to bring accrued expenses to books is:
Dr. The Relevant Expense Account
Cr. Accrued Expense Account, (a newly opened account)
With the amount of accrued expense. In Mr. John’s Case, the journal entry would be:
The effect of the above journal entry would be two folds:
- When preparing the Profit & Loss Account, the Telephone Expense will be shown at $4,330 ($3,460 + $870). and
- When preparing the Balance Sheet, Accrued Telephone Expense, $870, will be shown as a current liability.
Accrued Interest Expenses
For example, assume that on July 1, 2019, the Dogget Company borrows $10,000 from a local bank at Both principal and interest are payable in four quarterly installments, beginning October 1, 2019. series of journal entries through January 2, 2020, including the December 31, 2019 adjusting journal entry, is as follows:
In the above example, the note and the interest are paid quarterly. The interest based on the previous outstanding principal balance of the note. Therefore, on October 1, 2019, interest expense is $200, or 8% of $10,000 for 3 months. The interest expense for the next quarter is based on the new balance in the Note Payable of $7,500. An adjustment must be made on December 31, 2019, to record the interest expense that was incurred between October 1, 2019, and December 31, 2019, but that will not be paid until January 2, 2020. Finally, the journal entry on January 2, 2020, reflects the second payment of principal and interest.
Accrued Salaries Expenses
Salaries expenses are another example of accrued expenses for which adjusting entries normally are made. An adjustment necessary because the date that the salaries are paid does not necessarily correspond to the last date of the accounting period. Therefore, accrued salaries payable must be recorded for salaries earned by employees but unpaid through the end of the accounting period.
For example, assume that a firm pays its salaries every Friday for the workweek ending on that day. For simplicity’s sake, also assume that the firm began operations on Monday, January 2, 2017; the first payday of the year was Friday, January 6, 2017; and weekly salaries total $1,500. After the last full week of the year on December 28, 2017, the salaries T account appears as follows:
Because the payday for the week beginning Monday, December 31, 2017, is not paid until Friday, January 4, 2018, it is necessary to make an adjusting entry to accrue salaries through December 31, 2017. This requires an entry to debit Salaries Expense and to credit Salaries Payable. In this case, the amount of accrued salaries at December 31, 2017, is for one day’s salaries, or $300 ($1,500 / 5 days — $300). The salaries for the next 4 days of the week, or $1,200, are the expense of the next year, 2018. The timeline below shows the total amount of salaries expense for the week ended Friday, January 4, 2018, and how much expense should be allocated between the two years.
Finally, the adjusting journal entry at December 31, 2017; the entry to record the payment of salaries on January 4, 2018; and T accounts are:
When the salaries are paid on January 4, Cash is credited for the full week’s salaries. Salaries Payable is debited for the salaries recognized in the prior period, and Salaries Expense is debited for the current period’s salaries.