Accrued expense is expense which has been incurred but not yet paid.
Expense must be recorded in the accounting period in which it is incurred. Therefore, accrued expense must be recognized in the accounting period in which it occurs rather than in the following period in which it will be paid.
As expense will be debited to record the accrued expense, a corresponding payable must be created to account for the credit side of the transaction. The accounting entry to record accrued expense will therefore be as follows:
|
Debit |
Expense (Income Statement) |
|
|
Credit |
Expense Payable (Balance Sheet) |
|
Example
ABC LTD pays loan interest for the month of December 2010 of $10,000 on 3rd January 2011. ABC LTD has an accounting year end of 31st December 2010.
ABC LTD will recognize interest expense of $10,000 in the financial statements of year 2010 even though it was paid in the next accounting period as it relates to the current period. Following accounting entry will need to be recorded to account for the interest expense accrued:
|
Debit |
Interest Expense |
$10,000 |
|
Credit |
Interest Payable |
$10,000 |
On the date of payment of interest (i.e. 3rd January of the next year) following accounting entry will need to be recorded in the subsequent year:
|
Debit |
Interest Payable |
$10,000 |
|
Credit |
Bank |
$10,000 |
Quiz
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Question
ABC LTD has a year end of 31st December 2011. Which of the following transactions and events should give rise to accrued expense in ABC LTD’s financial statement?
ABC LTD receives rent income in advance. Rent for the first quarter of 2012 is due on 31st December 2011.
Incorrect.
Although rent advance is outstanding on 31st December 2011 the rent expense must not be accrued in the 2011 financial statements as it relates to the subsequent accounting period and therefore has not incurred by the year end.
ABC LTD pays salary to its employees on 25th of every month.
Correct.
Salary expense must be accrued for 6 days (26th Dec to 31st Dec) as it relates to the current accounting period even though it will be settled in the next accounting period.
XYZ LTD provides janitorial services to ABC LTD. The related expense for the month of December 2011 had not been recorded in the financial statements as the related invoice was received in February 2012.
Correct.
Although ABC LTD received the invoice in February, it must recognize the expense and accrued liability in the 2011 financial statements since it had received the janitorial services in the current accounting period. The amount recognized may be estimated by for example taking the average of the recent most invoices.