ACCRUED EXPENSES: Recognition, Adjusting Entries, Financial Impact

Accrued expenses represent obligations for goods or services received but not yet paid for at the end of the accounting period. These expenses are recorded using adjusting entries to comply with accrual accounting and accurately reflect liabilities.

1. What Are Accrued Expenses?

Accrued expenses are costs that have been incurred during a period but remain unpaid at the reporting date.

They are recognized to ensure that expenses are matched with the revenues they helped generate—even if no invoice or payment has yet been made.

Common examples include:

• Wages and salaries payable

• Utilities used but not yet billed

• Interest expense accrued

• Income tax payable

• Professional fees or services rendered

2. Initial Recognition and Adjusting Entry

When the expense is incurred but unpaid, a liability must be recognized.

General entry at period-end:

• debit Expense

• credit Accrued Expenses (Liability) or relevant payable account

Example

Assume a company owes $4,000 in salaries for work done in the final week of December but will pay on January 5:

• debit Salaries Expense ............................ 4,000

• credit Salaries Payable ............................. 4,000

This records the cost in the correct accounting period even before payment.

3. Reversal or Payment in the Next Period

When the payment is made in the following period, the liability is cleared.

Example:On January 5, when salaries are paid:

• debit Salaries Payable .............................. 4,000

• credit Cash ..................................................... 4,000

Alternatively, if not reversed, the expense is not recorded again—only the liability is settled.

4. Matching Principle and Accrual Accounting

Accrued expenses are essential to match expenses with revenues in the period they relate to.

Without these adjustments:

• Expenses are understated

• Liabilities are understated

• Net income is overstated

This is particularly important for financial statement users assessing profitability and obligations at period-end.

5. Comparison with Prepaid Expenses

Aspect	Accrued Expenses	Prepaid Expenses
Timing	Incurred, not yet paid	Paid, not yet incurred
Balance Sheet Impact	Liability	Asset
Income Statement	Expense recognized now	Expense deferred

6. Common Accrual Examples and Adjustments

Type	Period-End Adjusting Entry
Utilities used	debit Utilities Expense / credit Utilities Payable
Interest on loans	debit Interest Expense / credit Interest Payable
Wages owed	debit Salaries Expense / credit Salaries Payable
Professional services	debit Legal or Consulting Expense / credit Accounts Payable

7. Financial Statement Presentation

• Balance Sheet: Accrued expenses appear as part of current liabilities.

• Income Statement: Related expense is recorded in the correct reporting period.

• Cash Flow Statement: Payment appears in operating activities when cash is disbursed—not when the expense is accrued.

8. Risk of Omission

Failing to record accrued expenses may lead to:

• Inaccurate net income

• Undervalued liabilities

• Audit adjustments

• Misleading financial ratios (e.g., current ratio, return on assets)

Regular cut-off procedures and internal reviews help ensure complete accruals.

Key take-aways

• Accrued expenses recognize unpaid but incurred costs for accurate period reporting.

• They fulfill the matching principle and maintain liability integrity on the balance sheet.

• Adjusting entries at period-end ensure financial statements reflect all obligations.

• Timely accruals are essential for reliable reporting, budgeting, and compliance.

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