Accruing expenses is the process of recognizing expenses that have been incurred by a business but not yet paid for. This method of accounting allows a company to accurately reflect the liability that has been created by the receipt of a good or labor performed before the payment has been remitted. Using this process shows the effect of the specific event when the transaction occurs rather than when the payment is made. Typical examples of accrued expenses can include wages, interest, property tax, rent, commissions/royalties and utilities.
The process of accruing expenses is considered to be the standard practice for most companies because it provides a significantly more accurate picture of their financial position. The opposing process of recognizing revenue and expense would be using cash accounting, or recording a transaction only when cash is exchanged. Although cash accounting is less costly and less complex to implement, it is not an effective method of determining the financial position of a company at a given point in time. The difference between these two accounting methods can be demonstrated in the following scenario:
Scenario “Company A”:
Company A has 50 salaried employees and processes payroll on a bi-weekly basis. At the end of the current month employees were paid through Friday the 26th with 5 calendar days remaining in the period. The remaining 5 calendar days in the current month represent salary expense that has been incurred, but not yet paid to the employees.
Cash Accounting would recognize the expense for the remaining days in the following month when the salaries for this period were paid out. This method could cause large fluctuations in the financials from month to month depending on when the pay periods were to fall.
Accrual Accounting would determine the incurred salary expenses for the remaining days and create an adjusting journal entry to recognize this expense in the month that it was incurred. This method would allow the company to more accurately analyze expenses from month the month and recognize the expense when it was incurred.Written by: David Galante TGG Accounting