Accrued expenses are liabilities arising because a corporation realises expenses it has not paid. These expenses arise according to the matching principle of accounting, wherein expenses are recorded in the same period as the revenues they generate regardless of the timing of cash transactions.
Nature of Accrued Expenses
Generally, accrued expenses include those operational expenses that recur in a time pattern, such as employee salaries and wages, utility consumption, interest on loans, and rent. Their core definition is that they are measured as hosting liabilities for services or goods consumed and received.
Accounting for Accrued Expenses
Journal Entry
Expenses at an adjustment journal entry must be accrued at the close of the accounting period for where an expense occurred. It involves:
- Debiting (increasing) the relevant expense account.
- Crediting (increasing) the accrued expense liability account.
Thus, it properly affects the expenses in that accounting period.
Subsequent Payment
Similarly, another journal entry is needed to pay for accrued expenses. This one will:
- Debit (decrease) the accrued expense liability account.
- Credit (decrease) the cash or bank account.
Realising the obligation to settle shall be reflected here.
Importance of Accrued Expenses
Accurate reporting of accrued expenses is crucial to ensure financial statements are not misleading. Failing to report them properly can understate liabilities and expenses while overstating net income and assets. This misrepresentation can lead to incorrect decisions by investors, creditors, and other stakeholders.