Accounting for accrued expenses is very important, especially when an entity adopts accrual basis accounting. In day-to-day operations, we often encounter such key accounting terms. So what are accrued expenses? What is the proper accounting for accrued expenses?
What is Accrued Expense?
Accounting for accrued expenses properly is the key task for accountants. Before jumping into how to account for accrued expenses as well as the different types of accrued expenses, let’s first understand the definition.
Accrued expenses refer to circumstances where expenses have been incurred, but payment has not been made, nor sometimes an entity has not received the invoice.
Similarly, another definition has been given as follows:
Accrued expenses refer to any costs or expenses incurred but the invoice has not been received nor paid. Such expenses shall be recorded and presented in the Income Statement or Profit and Loss account when such expenses are incurred with the corresponding entry to the accrued expense account.
Accrued expenses are the liabilities on expenses incurred but not yet paid to the vendors or suppliers. Typically, we, in practice, treat accrued expenses as the current liabilities, which shall be presented in the Balance Sheet. This is because these accrued liabilities are for a short period of time, less than twelve months.
Now, we already understand the definition of accrued expenses. Next, we will go into further detail on different items of it as well as the journal entries for such accruals.
What are the Common Items of Accrued Expenses?
In accounting, many items relate to accrued expenses. Basically, any expenses or costs incurred but not yet received invoice nor paid are considered accrued expenses. Thus, even though an entity has not received invoices nor paid to suppliers, such entity shall record or recognize them as expenses in the accounting book to be in line with the accrual basis accounting.
Below are common items of accrued expenses:
- Salary or wage payable
- Interest payable
- Utility payable
- Corporate income tax payable
- Commission payable
- Other operating expenses
Journal Entries for Accrued Expenses
Commonly, accrued expenses are considered current liabilities and presented in the Balance Sheet or Statement of Financial Position.
The journal entries for accrued expenses are simple. We just need to record the expenses on the debit side and accrued expense account on the credit side. Typically, we use specific accrued expense accounts depending on their nature. For example, the accrued expense for salary expense should be salary payable, etc
Below is the simple journal entry for accrued expenses:
| Account Name | Debit | Credit |
|---|---|---|
| Expenses (P&L) | XXX | |
| Accrued expenses (BS) | XXX |
Now, let’s jump into the detailed nature of each accrued expense as well as the practical journal for accrued expenses that an entity shall record and present in the financial statements.
1. Salary and Wage Payable
When an entity hires employees or workers to work for the entity and the service of the employees and workers has been incurred, but the expenses have not been made. That entity shall record such expenses even though the payment has not been made.
For instance, on 31 January 2019, ABC Co incurred salary expenses and wages for US$50,000 and US$15,000 of which has not been paid for. This is due to the late processing of documents at the bank. Therefore, the salary and wage were debited from the company’s account the next day.
In this case, ABC Co shall recognize and record salary and wage expenses for a total of US$50,000 even though ABC Co has not paid US$15,000 as these expenses have already been incurred during that month.
The journal entry for accrued salary expense for the above example would be as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Salary and wage expenses | $50,000 | |
| Cash or bank | $35,000 | |
| Salary and wage payable | $15,000 |
The salary and wage payable of US$15,000 will be presented in the Balance Sheet as current liabilities.
2. Interest payable
Similar to salary and wage expenses, if an entity has a bank loan or any overdraft facilities (OD) and incurred interest expense as a result of using such facilities, such interest shall be accounted for as an expense even though the entity has not received a statement from the bank nor paid.
For example, at the end of 31 December 2019, ABC incurred an interest expense of US$1,000, and this interest has not been paid. Such interest shall be paid to the bank on 02 February 2019.
In this case, ABC Co shall record and recognize interest expense of US$1,000 in the accounting book of 31 January 2019 and present the interest payable as accruals in the Balance Sheet under the current liabilities section.
The journal entry for accrued interest expense are as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Interest expense | $1,000 | |
| Interest payable | $1,000 |
3. Utility payable
Utilities such as electricity and water usage are also commonly called one type of accrued expense. The invoice of such utilities always comes late after the accounting period. Thus, an entity shall need to record the accruals of utility expenses in its accounting book.
For example, based on historical past experience, ABC Co normally incurs utility expenses of approximately US$2,000 per month. As of 31 January 2019, ABC Co has not received the invoice from the utility company yet.
Thus, in this case, even though we have not received invoices from utility providers, however, from past experience, ABC Co knows that the utility expenses are approximately US$2,000 per month. Therefore, ABC Co shall need to record the accruals of utility expenses for US$2,000. Any under or over-accruals shall need to adjust in February 2019.
The journal entry for accrued utility expense is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Utility expenses | $2,000 | |
| Utility payable | $2,000 |
Assume further that, on 15 February 2019, ABC Co receives the invoice, and the utility expenses are actually US$1,900. ABC Co pays the utility bill immediately on that day. Therefore, at the time of payment, ABC Co shall also need to reverse such excessive accruals in February 2019. Thus, the accounting entries for payment and such reversal are as follows:
| Account Name | Debit | Credit |
|---|---|---|
| Utility payable | $2,000 | |
| Cash or bank | $1,900 | |
| Utility expenses | $100 |
4. Corporate income tax payable
Basically, the corporate income tax (CIT) is due and paid after the accounting period, usually in the following year after an entity closes the year-end book. For some jurisdictions, in order to pay the final corporate income tax, each entity shall need to have an audited financial statement from competent, qualified auditors or accounting firms.
Thus, on the monthly basis, each entity shall need to make an accrual for such CIT to avoid big expenses at the year-end. Each entity can estimate the CIT based on the net profit before tax each month multiplied by the applicable tax rate depending on each jurisdiction.
For instance, ABC Co is located in Singapore. The applicable CIT rate in Singapore is 17%. On 31 January 2019, ABC Co had a profit before tax of US$30,000. Usually, based on past experience, the final CIT is closest to the accruals based on the profit before tax multiplied by the CIT rate.
Therefore, in this case, the estimated CIT expense for January 2019 is US$5,100 (US$30,000*17%).
Thus, the journal entry for accrued CIT is as follows:
| Account Name | Debit | Credit |
|---|---|---|
| CIT expense | $5,100 | |
| CIT payable | $5,100 |
5. Other operating expenses and other accrued expenses
There are also other types of expenses where each entity incurs expenses, but the invoices have not been received nor paid. For example, commission expenses and other operating expenses.
Hence, each journal entity shall record those expenses in the accounting book when such expenses incurred, regardless of not receiving an invoice or have not made a payment.
Conclusion
In conclusion, each entity shall need to account for accrued expenses properly regardless of whether such entity has not received invoices or paid. This is the basic accrual accounting concept.
