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Identifying and capturing accrued expenses

From our experience, we’ve noticed that some smaller companies tend to struggle with the concept of accrued expenses. They are unsure about what they should accrue for and when they should accrue for it.

Accrued expenses

To help clear this up, let’s first start by talking about what an accrued expense is. The definition of an accrued expense is an expense that has been incurred but not yet paid. What this means is that from the time the expense is incurred, until the date that they are paid, these expenses should be recognized as a liability on the balance sheet.

Note that accruals are typically recorded at the end of an accounting period such as month-end, quarter-end or year-end. The concept behind this is that under accrual accounting, you need to get all of your expenses and liabilities recorded in the period in which they were incurred, as opposed to recording them when they are paid, which would be the cash method of accounting.

Journal entries

The typical journal entry for recording an accrued expense would be a debit to an expense account and a credit to an accrued liability account. This entry ensures that you have properly recorded the expense and liability in the period in which the expense has occurred. When you finally make the payment for the accrual, you will relieve the accrued liability by debiting the accrued liability account and crediting cash. However, sometimes the accrual is for an amount that is less than the amount paid. This occurs when an expense is for a service period that straddles year-end. In these instances, the period-end accrual will be reversed, and the cash payment will fully hit the related expense accounts. Often, we see clients do this for all period-end accruals, so that the payments are always posted to the related expense accounts and period-end accruals are made to get the expense recorded in the proper period.

Common accrued expenses

Common accrued expenses that you should be aware of are:

  • Wages and payroll taxes
  • Bonuses
  • Commissions
  • Interest
  • Real estate and property taxes

Even though these are the most common, there are many more situations that require an accrual to be recorded. Knowledge of events or transactions that occurred during a period, but will not be paid until a subsequent period, is necessary to identify any missing accruals. Also, before closing out a period, review of expenses compared to prior periods or budgets can help identify if there are any missing accruals.

How much to accrue for

When it comes to figuring out how much you should be accruing for, you should start by determining how much of your expense relates to the period under which you are recording the accrual. For expenses with services periods that straddle period-end, this is usually done by allocating the expense to each period based upon the number of days. In addition, you may not always know what the expense is going to be when the invoice is received. In these situations, many companies estimate the current period accrual based upon the bill received in the prior period.

Identifying and capturing period-end accruals helps ensure that you have accurate financial reporting for each period, which allows for comparability between periods. Developing a process to identify and capture necessary accruals should be a part of everyone’s financial statement close process.