Question

The term "accrued expenses" is often mistaken by individuals who think it is an expense. Please explain why "accrued expenses" is not an expense.

Give two example of an accrued expense that will help individuals remember an accrued expense is a liability

Answer 1

Answer : A. Accounting is the language of business; affairs of a business unit are communicated to others as well as to those who own or manage it through accounting information which has to be suitably recorded, classified, summarized and presented. To make the language convey the same meaning to all people, as far as practicable, and to make it full meaning, a number of concepts have been followed. Now for the purpose of bookkeeping mainly two (2) methods are followed such as

1) Cash Method

Under this method income is equivalent to cash received, expense is equivalent to cash paid. Thus, it is clear that the cash received in a specified period is the income of that period and the cash paid is the expense of that period. So, the difference between the cash received and cash paid is the profit. If an amount related to that particular period is not received within that period, it is not considered as the income of that period. Similarly, if an amount related to that particular period is not paid within that period, it is not considered as the expense of that period. This method is very easy and it is followed by small traders.

This method cannot be treated as a scientific method because the conditions mentioned above are not found in actual practice in a large organization.  

2) Accrual Method

This is more practicable and scientific system followed in large organization. To find out income under this method, accrued revenues during a period are matched with accrued expenses. For the determination of the period of receipt, the criterion is to see in which period it has accrued and not the period in which it has been received. Similarly, the expenses are also determined on the same basis. We have to see the period to which they are related and not the period in which they are paid. In other words, we can say that expenses recognized not when a disbursement is made, but when a cost expires or is consumed in the creation of revenues.

As explained above in "accrual method", "accrued expenses" are recognized not when a disbursement is made, but when a cost expires or is consumed in the creation of revenues. Hence, it can be concluded that "accrued expenses" is not an expense.

B. Two examples of Accrued Expenses are as follows:

i) Accrued Salaries - Salaries earned by the employees for a particular month which will not be paid in the same month but in the subsequent month or as decided by the employer.

ii) Accrued Interest - The interest on a loan, borrowed by the company in the beginning of a month for one year, will only become due on maturity.