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Why Is There a Rush in the Accounting Section?
What is an accrued expenses? Everyone inside the Marigold Shopping Convenience Store's accounting section is in a hurry. It is already Friday and everybody is told to finish the financial reports for Monday's monthly meeting. Manager Stevenson has made a lot of telephone calls, asking if there are still some major tasks to do for the reports before the day ends. "They are going to finish the financial reports before going home, Sir," says Miss Ballesteros, the secretary. "They are already working on the accrued expenses, the last group of adjusting entries that are necessary in the reports."
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What Is an Adjusting Entry?
In conformity with the accrual method of accounting, the balance sheet or the so-called financial standing report of the business includes expenses and assets that are recognized even before they are paid or collected. These expenses and assets are typically periodic and recorded on the company's reports because of the high probability that they ultimately will be paid or collected in the next accounting period.
If it is an asset, it is categorized as an accrued asset or asset receivable like the accrued interest income. If it is a liability, it is recorded as an accrued expense or expense payable--like interest, salaries, or taxes.
Accrued assets are the opposite of unearned income. Even if they are expected to be collected after the balance sheet is done, they are still included because they are already earned. On the other hand, accrued expenses are the opposite of prepaid expenses. Even though they will be paid the next accounting period, they are recorded on the balance sheet because they are already incurred.
This article will focus on the accrued expense.
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What Are Examples of Accrued Expenses? How Are They Calculated?
Generally, all kinds of expenses that have benefited the business during a given accounting period but are not yet paid are considered as accrued expenses. This article will focus on the most common ones: accrued salaries, accrued interest expense, and accrued taxes.
Marigold Shopping Convenience has contractual store employees who are paid every week on Saturday. Since this store is situated in a classy suburban area, the authorities do not permit the store to open on Sundays because of the traffic occurring along private roads. In this case, the employees are only working 6 days a week. A monthly financial report is always prepared. The weekly payroll is $2,700.
The payroll is prepared every Saturday morning. Employees can collect their wages at exactly 4:00 at the afternoon, 2 hours before the store closes to the public. During the month of September 2009, the last Saturday payroll date is September 27. Since the employees have to work on September 29 and 30, and the two-day payroll is a part of the total September operating expenses, they are considered as salaries payable or accrued salaries at the end of month of September and are to be paid on the first Saturday payroll of October 2009. The employees can collect their wages for September 29 and 30 on October 4, 2009.
Before computing the accrued salaries, let us all remember that an account has two sides: The left or the DEBIT side, and right or the CREDIT side. Expenses are normally posted at its left side while liabilities are posted at its right side.
On September 30, 2009, the accountant will record the accrual as:
Salary Expenses are increased by placing a total of $5,400 ($2,700 multiplied by 2 days, September 29 and 30) on its left side while an account called Salaries Payable or Accrued Expenses will be created and placed at its right side with the same amount, $5,400)
Accrued Interest Expense
Just like any entity, Marigold Shopping Convenience obtains loans from banks to augment its cash flow for operations. During the current year, it is able to borrow funds from Herald Bank on September 1, 2009. The assistance granted by the bank is a six-month, 5% bank loan of $10,000. Based on the agreement, this loan will be paid at the end of February 2010.
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To calculate the amount of the accrued interest expense, let us analyze the problem: Since the maturity date at the end of February 2010 and date of the ending period, December 31, 2009, are different dates, the interest incurred from September 1 to December 31, 2009 will not be paid at the end of the period, December 31, 2009, so it is outstanding as payable at the end of December 31, 2009, in conformity with the accrual method of accounting.
Computation of the accrued interest expense:
Formula: Principle amount multiplied by the interest rate multiplied by the number of months
Substituting the formula: $10,000 multiplied by 5% multiplied by 6 months over one year
$10,000 multiplied by .05 multiplied by 6/12 equals $250.
Marigold computes its yearly income tax one week after the end of the accounting period. This tax is also an operating expense of the said accounting period but paid three months later.
To include the tax in the financial reports:
After computing the tax of $2,000, for instance, the accountant creates an account called Income Tax Expense, placing the amount at its left side, and a corresponding liability account called Accrued Taxes placed at its right side.
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Conclusion: Why Recognize Accrued Expenses in the Financial Reports?
As stated in the first section of this article, the inclusion of the accrued expenses is in conformity with the accrual method of accounting. It means that all income and expenses are that already earned and incurred during a certain period should be included in that particular period. If these accrued expenses are not included in the operating expenses in the period they have been incurred, the total operating expenses of the said accounting period will be understated with a corresponding overstatement of the net income. Thus, the financial reports will not show a fair presentation of the financial figures of the company.
This is what is an accrued expense in the case of Marigold Shopping Convenience Store:
For the company, after adjusting the accounts and determining the unadjusted operating expenses amounting to $4,000, the total Adjusted Operating Expenses amount to $8,866.67, computed as follows:
Unadjusted Operating Expenses $4,000, plus Accrued Salaries, $2,700, plus Accrued Interest Expense, $166.67, plus Accrued Taxes, $2,000, amounting to $8,866.67
Book and Image Credits:
Basic Accounting 1 by Balada and Balada, 2010