In any business organization, expenses arise in several forms and at different time intervals. All expenses are accounted for, or recorded in the cash book, cash flow, and also in the final accounts that are prepared and finalized at the end of every accounting period.
Accrued expenses are the ones which exist in the guise of a liability, and are recognized in the books of accounts even before the expenditure actually takes place. The accounting treatment, and the consideration of such expenditures in bookkeeping is fairly different, and has been discussed in the following paragraphs.
Understanding Accrued Expenses
If you are wondering what are accrued expenses, then here's an explanation. Financial accounting is conducted to report incomes and expenditures, cost accounting is done to ascertain costs and expenses, managerial analysis of accounting is done to ascertain whether a certain transaction is profitable or not.
Thus, all the three branches deal in some or the other way, with transactions. The transaction can, of course, be an income or expenditure. From volume (amount of dollars) perspective, the transactions can be classified into fixed and variable.
As the titles suggests, fixed expenditures occur in same quantities, recurring after every accounting period. A prominent expenditure is the payroll of the firm. The variable expenditures occur in variable amounts.
Accrued expenses in accounting are expenditures which are recognized in the books of accounts as liabilities. Now, both types of expenditures, fixed and variable, tend to be accrued expenses, recognition of the income makes the income an accrued one.
In such a scenario, the two probable implications of the expenditure are: one, a provision is made by the company in advance to sustain the expenditure, or the expenditure is simply set aside on the side of liability.
Though the accrued expenses payable accounts, are just acknowledged in the books of accounts, the recognition often plays a much more important role in the managerial and cost accounting. The accrued expense is the exact opposite of prepaid expenses.
Balance Sheet of Accrued Expenses
The nature of every accrued expenditure is different, it thus has different implication in every case, affecting all related statements, and also the final accounts and balance sheet. Here are some common examples:
- Let us get to know the first one, the simplest one, payroll. The monthly salaries become accrued as the month progresses and on a daily balance sheet change, they get recorded in the liability section of the balance sheet.
The payroll is calculated in several different ways, such as unit based payments, hour based payments or whatever is the policy of the company. The accrued expense progresses on the balance sheet as the days progress.
On the end of the period, or on the day when the actual payment is made, the payroll account, cash book, cash book cash flow and the balance sheet all show the payment transaction.
- A loan that is depicted on the balance sheet is a classic example of accrued interest. The total loan amount, plus the interest and other fees or payments are recorded on the liability side of the balance sheet.
On the due date of the installment payment, the transaction is depicted in the profit and loss account, cash book, cash flow statement and the requisite installation amount is deducted from the liability.
- Annual taxes are another example that are ascertained on almost a daily basis, and are later paid off through the cash book and cash flow. Again, taxes that are payable are recorded as liability.
- Some expenditures are contingent or contingent liabilities, that is they can be potential expenditures or can be incomes. For example debtors of the company.
Debtors may turn into bad debts or bills receivable may turn into dishonored bills. These elements exist on the balance sheet as assets. Often a certain provision (amount) is set aside, and is set out on the liability side so that the expenditure, or rather loss, can be easily sustained by the firm.
There can be several variants of accrued expenses, with different implications, differing from situation to situation. A proper balance sheet analysis effectively helps the management to make provisions for the accrued expenses.