Have you ever been baffled by accounting types telling you that a certain expense has been accrued? Some time ago I told someone about accrual of her expenses, and she was offended. I had to tell l her that to accrue something was not a horrible thing… Basically, to accrue an expense is to recognize a transaction before it has been paid or entered in the accounts payable system. In order to be accrued, an expense must have occurred during this period. If you used a service or purchased goods to be used now, then you recognize that expense now.
Accruals are usually made when books at closed, sometimes every month and for sure at year-end. Examples of accrued expenses could be:
* Payroll for work performed this period, but paid in the future — VERY COMMON
* Commission for sales that happened now, but will be paid in the future
* Utilities used this period, but paid in a following period
* Purchases for paper to be used this period, but paid in the future
* Expenses for an event that happened this period, but paid in the future
The point is to recognize the expense in the income statement, matching it with revenue for the same time period.
Oftentimes accountants estimate accrued expenses. This may happen when they don’t know how much these expenses will cost. Accountants usually look at accrued expenses of a prior period to make sure they don’t forget any transactions. If they notice expense accruals for insurance, for instance, then they know that they may have insurance expenses out there to be accrued.
Sometimes business people get confused between budget numbers and accruals. You do NOT accrue an expense just because you budgeted for it. You accrue an expense because the transaction actually happened during the period. This means that budget versus actual expenses variances may be explained by accrued expenses.
For the technically minded, below is the journal entry to book an accrued expense:
Debit — Different types of expenses reporting in the income statement
Credit — Liability accrued expense account, reporting in the balance sheet
When the accrued expense is paid, the journal entry is:
Debit — Liability account
Credit — Cash
A common problem is to book the expense in the accrual and again when the bill is entered in the accounts payable system. To avoid this double-booking, the original accrual entry is reversed as the bills are paid. This can be time-consuming and error-prone, but it is the traditional way to avoid recognizing the same expense twice.