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Accounting for Accrued Expenses

One of the primary tasks of the accountant during the period-end closing process is the
calculation of expense accruals, of which there are potentially a great number. There will
be a number of types of invoices or bills from internal of the company (Human Resource,
and Marketing) and vendors that will arrive several days after the end of the period, such
as maintenance billings, telephone bills, electricity and utilities. The accountant can
anticipate their arrival by accruing for them based on a checklist of invoices that are
typically late in arriving, and for which an estimate can be made that is based on invoices
from previous reporting periods.

This post describes a wide range of accrued expenses, and how they should be accounted
for. But, before that, period-end cutoff is worth discussing. Follow on…

Period-End Cutoff and Accrual Transactions

If an accountant were to issue financial statements immediately after the end of a reporting
period, it is quite likely that the resulting financial statements would underreport the
amount of accounts payable and accrued account might not be even exist. The reason is that
the company may have received some billings after the closing date. Such bills are: accrued
bonuses, accrued commissions, accrued property taxes, accrued royalties, accrued sick time,
accrued vacations, accrued wages, accrued warranty claims and the like. Telephone, utilities and
other repetitive bills often come late that more than 10 days after the closing date. Accrual
approach very well addresses this issue.

The key activity for the accountant is to compare the receiving department’s receiving log for the
few days near period-end to the supplier invoices logged into that period, to see if there are any
receipts for which there are no supplier invoices. If not, the accountant can accrue the missing
invoice at the per-unit rate shown on the originating purchase order, or else used the cost noted
on an earlier invoice for the same item.

Proper attention to the cutoff issue is extremely important, since ignoring it can lead to
wide gyrations in reported income from period to period, as invoices are continually
recorded in the wrong period.

Accounting For Accrued Expenses

Here are the most common ones:


1. Accrued Telephone/Electricity/Utilities - Often times the telephone/electricity and other
utilities bills are arrived (or autodebited by the bank) after the end-period closing. While, it does
not make sense for the accountant to hold the end-period closing just to wait for the bills, closing
the book without these bills (or invoices) will lead to underreporting those expenses and
Accounts Payable which hence, will generate inaccurate report. The accrual approach can
push the inaccuracy to minimum. Since these bills are types of recuring, accountant should be
able to well estimate the expenses by using the previous bills. Here are the journal entries:

On the closing date (estimated):

[Debit]. Telephone (or Electricity or any other utilities)


[Credit]. Accrued Telephone (or Electricity or any other utilities)

When receiving the actual bills with actual amount:

[Debit]. Accrued Telephone (or Electricity or any other utilities)


[Credit]. Accounts Payable – Telephone (or Electricity or any other utilities)

Note: If the actual amount is not the same with the amount of the Accrued Telephone (or
Electricity or any other utilities), the different amount will need to be adjusted to the Telephone
(or Electricity or any other utilities) account and the Accrued Telephone (or Electricity or any
other utilities) before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Telephone (or Electricity or any other utilities)


[Credit]. Cash/Bank

2. Accrued Property Taxes - The accounting staff is usually notified well in advance by the
local government authorities of the exact amount of property tax that will be payable on a later
date. However, there is no reason to record the entire amount of this tax at the point of
notification; since property taxes do not vary much from year to year, the accountant can easily
record a monthly property tax accrual, and adjust it slightly when the exact amount payable
becomes known. Here are the journal entries:

On the closing date (estimated):

[Debit]. Property Tax


[Credit]. Accrued Property Tax

When receiving the actual bills with actual amount:

[Debit]. Accrued Property Tax


[Credit]. Accounts Payable – Property Tax
Note: If the actual amount is not the same with the amount of the accrued Property Tax, the
different amount will need to be adjusted to the Property Tax Expense account and the Accrued
Property Tax before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Property Tax


[Credit]. Cash/Bank

3. Accrued Warranty Claims - For the company that sells products/services with warranty, the
accountant should anticipates warranty claims by accruing an expense for warranty claims, based
on the company’s past history with claims for similar types of products or product lines. It may
also use industry information if in-house data is not available. If the data sources are fluctuated
in values, taking the biggest number is always more appropriate. Here are the journal entries:

On the closing date (Estimated):

[Debit]. Warranty Claims


[Credit]. Accrued Warranty Claims

When receiving the actual bills with actual amount:

[Debit]. Accrued Warranty Claims


[Credit]. Accounts Payable – Warranty Claims

Note: If the actual amount is not the same with the amount of the Accrued Warranty Claims, the
different amount will need to be adjusted to the Warranty Claims Account and the Accrued
Warranty Claims before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Warranty Claims


[Credit]. Cash/Bank

4. Accrued Commissions - The amount of commissions due to the sales staff may not be
precisely ascertainable at the end of the reporting period, since they may be subject to later
changes based on the precise terms of the commission agreement with the sales staff, such as
subsequent reductions if customers do not pay for their delivered goods or services. In this case,
commissions should be accrued based on the maximum possible commission payment, minus a
reduction for later eventualities; the reduction can reasonably be based on historical experience
with actual commission rates paid. Here are the journal entries:
On the closing date (estimated):

[Debit]. Commission
[Credit]. Accrued Commission

When receiving the actual bills with actual amount:

[Debit]. Accrued Commission


[Credit]. Accounts Payable – Commission

Note: If the actual amount is not the same with the amount of the Accrued Commisons, the
different amount will need to be adjusted to the Commission and the Accrued Commission
before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable - Commission


[Credit]. Cash/Bank

5. Accrued Royalties - A royalty expense accrual should be treated in the same manner as a
commission—if there is any uncertainty in regard to the amount due, record the maximum
amount, less a reduction for future eventualities that is based on historical results. Here are
journal entries should be made:

On the closing date:

[Debit]. Royalties
[Credit]. Accrued Royalties

When receiving the actual bills with actual amount:

[Debit]. Accrued Royalties


[Credit]. Accounts Payable – Royalties

Note: If the actual amount is not the same with the amount of the Accrued Royalties, the
different amount will need to be adjusted to the Royalties account and the Accrued Royalties
before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Royalties


[Credit]. Cash/Bank
6. Accrued Bonuses - Rather than waiting until bonuses are fully earned and payable to
recognize them, the accountant should accrue some proportion of bonuses in each reporting
period if there is a reasonable expectation that they will be earned and that the eventual amount
of the bonuses can be approximately determined. Here are the journal entries:

On the closing date (estimated):

[Debit]. Bonuses
[Credit]. Accrued Bonus

When receiving the actual bills with actual amount:

[Debit]. Accrued Bonus


[Credit]. Accounts Payable – Employee Bonus

Note: If the actual amount is not the same with the amount of the Accrued Bonus, the different
amount will need to be adjusted to the Bonus account and the Accrued Bonus before the
Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Employee Bonus


[Credit]. Cash/Bank

7. Accrued Vacations - The accountant should accrue for vacation hours earned, but only if they
are already earned as of the end of the reporting period. For example: if a company awards
vacation hours to its employees at a constant hourly rate that adds up to two weeks per year, then
it should accrue the difference between the amount accrued to date and the amount taken in
actual vacation hours. However, if there is a “use it or lose it” limitation that restricts the
number of vacation hours that can be carried forward into future periods, then the accrual is
limited to the maximum of this carry forward amount. Here are the journal entries:

On the closing date:

[Debit]. Employee Benefit – Vacation


[Credit]. Accrued Vacation

When receiving the actual bills with actual amount:

[Debit]. Accrued Vacation


[Credit]. Accounts Payable – Vacation
Note: If the actual amount is not the same with the amount of the Accrued Vacation, the different
amount will need to be adjusted to the Employee Benefit-Vacation account and the accrued
vacation before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Vacation


[Credit]. Cash/Bank

8. Accrued Sick Time - The amount of sick time allowed to employees is usually so small that
there is no discernible impact on the financial statements if they are accrued or not. This is
particularly true if unused sick time cannot be carried forward into future years as an ongoing
residual employee benefit that may be paid out at some future date. If these restrictions are not
the case, then the accounting treatment of sick time is the same as for accrued vacation time
above. Here are the journal entries:

On the closing date:

[Debit]. Employee Benefit – Sick Time


[Credit]. Accrued Sick Time

When receiving the actual bills with actual amount:

[Debit]. Accrued Sick Time


[Credit]. Accounts Payable – Sick Time

Note: If the actual amount is not the same with the amount of the Accrued Sick Time, the
different amount will need to be adjusted to the Employee Benefit-Sick Time account and the
Accrued Sick Time before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Sick Time


[Credit]. Cash/Bank

9. Accrued Wages and Payroll Tax - Even if a company times its payroll period-end dates to
correspond with the end of each reporting period, this will only ensure that no accrual is needed
for those employees who receive salaries (because they are usually paid through the payroll
period ending date). The same is not usually true for those who receive an hourly wage. In their
case, the pay period may end as much as a week prior to the actual payment date. Consequently,
the accountant must accrue the wage expense for the period between the pay period end date and
the end of the reporting period. This can be estimated on a person-by-person basis, but an easier
approach is to accrue based on a historical hourly rate that includes average overtime
percentages. One must also include the company’s share of all payroll taxes in this accrual. Here
are the journal entries:

On the closing date:

[Debit]. Wages
[Credit]. Accrued Wages

and:

[Debit]. Payroll Tax [company's shares]


[Credit]. Accrued Payroll tax

When receiving the actual bills with actual amount:

[Debit]. Accrued Wages


[Credit]. Accounts Payable – Wages

and

[Debit]. Accrued Payroll Tax


[Credit]. Accounts Payable – Payroll Tax

Note: If the actual amount is not the same with the amount of the Accrued Wages and/or Payroll
Tax, the different amount will need to be adjusted to the Wages and/or Payroll Tax account and
the Accrued Wages and/or Payroll Tax before the Accounts Payable is recorded.

On the pay date (actual amount after the adjustment):

[Debit]. Accounts Payable – Wages


[Debit]. Accounts Payable – Payroll Tax
[Credit]. Cash/Bank

There are a small number of cases in which employees do not cash their payroll checks.
This most commonly arises when an employee has left the company and moved away, so
that the company cannot track down the person’s whereabouts. In this case, the funds can
be deposited to an unclaimed wages account in the current liabilities section of the balance
sheet. Under some state laws, these funds must be forwarded to the state government after
they have gone unclaimed for a certain period of time. If so, the accountant should be very
careful in regard to the record keeping for these transactions. If there is no such state law,
the company should reverse the original payroll transaction, crediting the salaries and
wages account for the amount of the unclaimed check.

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