B3: 4.03 Recording accrued expenses

The effect of an accrued expense is to bring an expense that is initially recorded in a later accounting period forward to an earlier period. We an accrued expense is recorded we see an increase in an expense and the creation of a liability at the end of the earlier accounting period which will then be reversed at the start of the next period.

There are two ways to record an accrued expense in the General Ledger:

  1. By using a separate Accruals account
  2. Without using a separate Accruals account

We will illustrate how both methods work using the scenario below:

Scenario

A business has a year end of 31st December. On 31st January 2020 the business received its telephone bill of £480 plus VAT. The bill covered the cost of the business’ telephone for the period from 1st November 2019 to 31st January 2020.

Two of the three months covered by the bill (November and December) fall in the year-ended 31st December 2019 so two thirds of the net bill; i.e. £320 of cost must be recorded in the earlier year and the telephone expense for the year ended 31st December 2020 must be reduced by the same amount.

Recording an accrued expense using a separate accruals account

The increase to the expense will be debited to the expense account and the balancing credit will be recorded in an accruals account.

We will therefore record the following journal.

The journal will then be entered in the General Ledger accounts as shown below (the journal postings are recorded in blue). The balance brought down of £1,260 in the Telephone account represents the telephone costs incurred by the business up to 1st December 2020.

Now the accrual has been posted, the accounts can be closed down. As the accruals account represents a liability its balance will be carried down to the start of the next period. The telephone account however is an expense account and its year-end balance will be sent to the Profit & Loss account using the following journal.

The above journal will be posted into the General Ledger and the telephone account and accruals account can then be closed down for the year.

At the start of the new accounting period

At the start of the next accounting period (in this example, on 1st January 2020), we will reverse the accruals journal. This will have the effect of cancelling the liability and reducing the telephone expenses for this period by the amount that was accrued for and included in the previous accounting period.

The journal will be posted to the General ledger and then in due course the January bill for the telephone will also be recorded.

If we now look at the Telephone account there is a net balance of £180 (i.e. £480 debit less £320 credit), which represents the telephone costs for January.

Recording an accrued expense without using a separate accruals account

As an alternative, the accrued expense can be recorded without the use of an accruals account. Where this is done, the year-end accrual will simply be recorded as a balance to be carried down on the debit side of the expense account and will then be a balance brought down on the credit side of the account at the start of the next period.

The advantage of this second method is that no reversal of a year-end accrual is required at the start of an accounting period but it does make it harder for an accountant to identify and keep track of all the accruals existing at the year-end as they are not to be found in a single accruals account.

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