ACCRUED EXPENSES (ACCRUED LIABILITIES)

1 Section 3 ACCRUED EXPENSES ( ACCRUED LIABILITIES) IntroductionAccrued EXPENSES are EXPENSES that have been incurred, but not yet paid put it another way, an ACCRUED expense is paid after being recorded onthe books. Every adjusting entry for ACCRUED EXPENSES debits an expenseaccount, increasing EXPENSES on the income statement and reducing netincome, and credits a payable account, increasing liabilities on the to Record ACCRUED ExpensesThe general entry to record an ACCRUED expense is:[Various Titles] Expense(income statement expense account)[Various Titles] Payable(balance sheet liability account)To accrue expenseExamples of ACCRUED ExpensesAccrued EXPENSES include the following: Interest owed but not yet paid on borrowed ExpenseInterest Payable Rent owed, but not yet ExpenseRent Payable Commissions and royalties owed but not yet [or Royalty] ExpenseCommission [or Royalty] Payable19 Utility and telephone bills owed, but not yet paid.

2 Utilities [or Telephone] ExpenseUtilities [or Telephone] Payable Salary and wage expense owed, but not yet Expense*Salaries Payable*Many companies use Salaries Expense for employees paid by the week and Wages Expense for employees paid by the hour. Property and other taxes owed, but not yet [or Federal Income, State Income, etc.] Tax ExpenseProperty [or Federal Income, State Income, etc.] Tax PayableHow Failure to Make theAdjustment Affects theFinancial StatementsFailure to record an adjusting entry will have the following impacts on thefinancial statements: Liabilities will be understated on the balance sheet (because theomitted entry increases a liability account); EXPENSES will be understated on the income statement (because theentry increases an expense account); and, as a result, Net income will be overstated on the income ProblemsPROBLEM 1: GuCo pays sales reps a 5% commission on sales.

3 GuCohad 19X5 sales of $500,000, but paid only $21,000 in much does GuCo accrue in commissions on December 31?Mastering adjusting Entries20 SOLUTION 1: To compute: $500,000 sales for 19X5 x 5% = $25,000commissions payable in 19X5. $25,000 payable $21,000 actuallypaid = $4,000 ACCRUED commissions. The adjusting journal entry is:Commissions Expense4,000 Commissions Payable4,000To accrue 19X5 commissionsPROBLEM 2: On December 31, SuCo receives a $740 phone bill thatit will pay the following month. What entry does SuCo record on De-cember 31?SOLUTION 2: On December 31, SuCo records the following adjustingentry:Telephone Expense740 Telephone Payable740To accrue telephone expensePROBLEM 3: RaCo pays employees weekly on Friday. But 19X7 endson a Wednesday. If, for the last week of the year, gross payroll is$10,000, how much does RaCo accrue for salary expense?

4 SOLUTION 3: RaCo must accrue 19X7 salary expense for 3 of the5 days, Monday, Tuesday, and Wednesday, which is 60% (3/5) of theweek. To compute ACCRUED payroll expense (payroll expense incurredbut not paid) for the last week of 19X7: $10,000 x 60% = $6,000 accruedpayroll expense for 19X7. (The remaining $4,000 of payroll expense forthe week will be incurred in 19X8.)RaCo s ACCRUED payroll expense is recorded with an adjusting entry inthe general journal as of the last day of the business year:Salaries Expense6,000 Salaries Payable6,000To accrue salaries at year endWithout this entry, the company s 19X7 net income would be over-stated because the expense would not have been recorded for , 19X7 liabilities would be Interest PayableInterest payable is ACCRUED in the same way as interest receivable. On ashort-term note, the interest accrues (builds up) and is usually paid alongAccrued EXPENSES ( ACCRUED LIABILITIES) 21with the principal on the note s due date.

5 On a long-term note, the interest ispaid periodically, such as each month. If the accounting period ends beforethe interest is paid, interest expense is ACCRUED on the last day of that formula to compute interest for a period is:Face amount (principal) x annual interest rate x fraction of year = ACCRUED interestWhen a company gives a note to borrow money, the first entry is for the note:CashNote PayableTo record note payableSubsequently, interest expense is ACCRUED with the following entry:Interest ExpenseInterest PayableTo accrue interest expensePROBLEM 4: On November 1, 19X6, MiCo, which uses a calendaryear, borrows $100,000 at 12% interest. How much interest expenseshould MiCo accrue as of December 31, 19X6, and how does it recordthe accrual on that day?SOLUTION 4: To compute interest ACCRUED as of December 31:$100,000 principal x 12% annual interest = $12,000 x 2/12 (for Novem-ber and December) = $2,000 ACCRUED interest as of December 31.

6 Theadjusting entry in the general journal on December 31 is:Interest Expense2,000 Interest Payable2,000To accrue 2 months interest ($100,000 x 12% x 2/12)The interest expense is recorded as of December 31 because theexpense is incurred (owed, but not paid) as of the last day of the that in all three problems, the adjusting entry increases an expenseaccount, which reduces net income on the income statement, and increases aliability account, which increases liabilities on the balance adjusting Entries22 QUIZ 1 ACCRUED EXPENSES ( ACCRUED LIABILITIES) Problem the following adjusting journal interest expense of $3, property tax expense of $1, salaries expense of $10,000 Problem company has a 6-day workweek and payday is Saturday. Weeklysalaries are $12,000, and your company contributes to each employee spension by contributing 3% of salaries to the Pension Fund account.

7 Makethe adjusting journal entries when the accounting period ends on adjusting entry (if any) do you record if the accounting period endson a Saturday?Problem payroll for the last week of the year (your company uses a 5-day workweek) is $40,000 and December 31 falls on a Thursday. Record the adjusting journal entry at year company borrows $50,000 on a 6-month, 12% note on October 1. Yearend is November 30. Record the ACCRUED interest at November EXPENSES ( ACCRUED LIABILITIES) 23 Problem choice. Circle the correct kind of account is Taxes Payable?a. assetb. liabilityc. revenued. a company forgets to accrue utilities expense at year end, how does itaffect net income?a. Net income will be Net income will be Net income will be a company fails to record an adjusting entry for property taxes, thennet income will be ..a. unaffectedb.

8 Understatedc. overstatedd. understated or overstated depending on the ACCRUED expense is one that is incurred but not yet Trueb. an ACCRUED expense, payment follows recognition of the Trueb. FalseMastering adjusting Entries24 Problem in the ACCRUED expense is one that has been but not . expense is ACCRUED by debiting a(n) account andcrediting a(n) adjusting entry to accrue an expense (increases/decreases) net expense recorded as incurred but not paid is presented as a(n) on the balance the adjusting entries and any transaction entries on December 31 foreach of the December 31, 19X1, FaCo incurs wage expense of $8,000 for December 29-31 that has not been either recorded or for December of $2,300 will be paid on January the $1,000 in commissions payable on December 31, only $400 EXPENSES ( ACCRUED Liabilities)

9 25 QUIZ 1 Solutions and ExplanationsProblem Expense3,000 Interest Payable3,000To accrue interest Taxes1,200 Property Taxes Payable1,200To accrue property tax Expense10,000 Salaries Payable10,000To accrue salaries expenseProblem Expense4,000*Salaries Payable4,000To accrue salaries expense*$12,000 weekly payroll/6 days = $2,000 per day x 2 days (Monday and Tuesday)= $4,000 Pension Expense120*Pension Payable120To accrue pension expense*$4,000 ACCRUED salaries expense x 3% pension contribution = $120 the workweek ends on a Saturday, the company will pay salariesfor the entire week, so no salaries accrue ( ACCRUED EXPENSES areexpenses incurred before they are paid). Thus, no adjusting entryis recorded; only an ordinary transaction entry is , pension contributions might accrue depending on therules of the particular adjusting Entries26 Problem (or Salaries) Expense32,000*Wages (or Salaries) Payable32,000To accrue wages (or salaries)*$40,000 payroll x 4/5 of the week (Monday Thursday) = $32,000 payrollexpense ACCRUED for the Expense1,000 Interest Payable1,000To accrue 2 months interest expense ($50,000 x 12% x 2/12)Problem payable account is a a company does not record an expense, EXPENSES areunderstated (too low) on the income statement, and net income isoverstated (too high).

10 Not all EXPENSES are on the books, net income will , , payable (or liability) EXPENSES ( ACCRUED LIABILITIES) 27 Problem December 31, 19X1, FaCo records the following adjusting entries:1.$8,000 in ACCRUED wages (stated in the data) have been ACCRUED :Wages Expense8,000 Wages Payable8,000To accrue wages expense2.$2,300 in ACCRUED rent:Rent Expense2,300 Rent Payable2,300To accrue rent is a transaction entry for the commissions paid:Commissions Expense400 Cash400 There is an adjusting entry for ACCRUED commissions:Commissions Expense600*Commissions Payable600To accrue commissions expense*$1,000 commissions owed $400 paid = $600 adjusting Entries28 QUIZ 2 ACCRUED EXPENSES ( ACCRUED LIABILITIES) NOT SHOWNA ccrued EXPENSES ( ACCRUED LIABILITIES) 29