For an accrual example, you may spend $300 on office supplies in October but not get the bill until November. Why Accrued Expenses are ImportantĪn accrued expense journal entry documents in the company’s books that money will be spent for goods or services already obtained. That way, the ledger accounts for all income and expenses created during that time period. Using accrued expenses acknowledges that the liability is valid and records it as such. This doesn’t create an accurate depiction of the company’s health, because it doesn’t account for the liabilities that are owed. Without noting accrued expenses, a business can seem more profitable than it is during the time period under review. A business should use accrued expenses to produce more accurate financial reports and get a better idea of the financial health of the company. With an accrued expense, we make a journal entry along with an offsetting liability. What are Accrued Expenses?Īccrued expenses are expenses that are incurred but still pending payment. Using the cash-basis method is easier but doesn’t provide the same financial insights that the accrual method does. In other words, with accrual-basis accounting, the recording point is when the money is earned, not when money changes hands. With an accrual basis, transactions are recorded when the work is done or the cost is acquired. With the cash basis of accounting, all transactions are recorded when money changes hands. The accrual method of accounting is often contrasted with cash-basis accounting.Ĭompanies make an initial choice on how to account for income and expenses. Accrued expenses are also called accrued liabilities because they become a debt you owe, based on receiving a product, service, or operational expense. This is also a good reason to conduct account reconciliations for all balance sheet accounts at regular intervals, which will detect unreversed entries.Accrued expenses are expenses that your company has taken on but has not yet paid. If you expect to keep an accrual for a long period of time before reversing it, then make note of the accrual in the journal entry records, and review it as part of every month-end closing process until it is reversed. The key indicator of this problem will be an accrued liability of $20,000 that the accounting staff should locate if it is periodically examining the contents of the company's liability accounts. If you were to forget to reverse the expense in the second example, the accounting records would show a $20,000 expense in January and another $20,000 expense in February, where the February amount is erroneous. The key indicator of this problem will be an accrued account receivable of $10,000 that the accounting staff should eventually spot if it is regularly examining the contents of its asset accounts. What if you were to forget to make a reversing entry? In the first example, this means that the accounting records would already show $10,000 of revenue that was recorded in January, and will then show an additional $12,000 of revenue in February, so that revenue is overstated by $10,000 through the two-month period. The net result is the recognition of a $20,000 expense in January, with no net additional expense recognition in February. The invoice arrives, and you record it in February. You expect the invoice to arrive a few days after you close the month, so you create a reversing entry in early February for $20,000. You accrue a $20,000 expense in January for a supplier invoice that did not arrive in time for the month-end close. The net result is the recognition of $10,000 in revenue in January, followed by the recognition of an additional $2,000 of revenue in February.Īccrued expenses. The final billing, for a total of $12,000, is completed later in the month. You expect to invoice the customer in February, so you create a reversing entry in the beginning of February to reverse the original $10,000 revenue accrual. You accrue $10,000 of revenue in January, because the company has earned the revenue but has not yet billed it to the customer. Two further examples of how to use a reversing entry are:Īccrued revenue. Thus, a reversing entry has allowed us to properly record an expense during the period when the expense was incurred, rather than in a later period, when the company obtains the supplier's invoice. The result is that the $18,000 expense appears in the company's income statement in January, which is presumably when it was supposed to appear under the accrual basis of accounting, while there is no net recognition of any expense at all in February.
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