Accrued Expenses Broken Down | Adjusting Entries

in this video you'll find out what accrued expenses mean and I'll show you how they work with an example hey there welcome back to accounting star I'm James and in this video we're going to cover accrued expenses in accounting this is part of a playlist that I've put together covering adjusting entries in accounting which you can find linked up here and down below in the description so far we've covered the big picture of adjusting entries prepaid expenses and deferred revenue and very soon I'll be releasing the final installment where we'll cover the crude revenue so hit subscribe and click on the bell so you don't miss out on that one and painting more accounting content that's coming soon but in this video we're going to take on accrued expenses with an example so let's dive in in true accounting stuff style fashion we'll begin with the definition an accrued expense is a past expense that hasn't been recorded or paid for yet let's pause for a moment think about what this means an accrued expense is a past expense that hasn't been recorded or paid for yet so this expense will be recorded or paid out in the future but right now in the present we're still waiting for that to happen got it this will all become clearer with the example that we'll get into shortly but first let's think about how a typical business transaction works imagine that we're the buyer and we want to buy something from someone the seller they send us the goods or provide us with a service and in addition to that they hand us an invoice in return we pay them in cash voila transaction complete with the crude expenses the seller provides us with the goods or services sometime in the past but we don't receive the invoice from them all made the payment to them until later in the future why why does all of this matter because as financial accountants we like to use the accrual basis of accounting and in a call accounting expenses are recorded as they are incurred not when cash changes hands I like to think of payments as accounting triggers when we pay money out of our bank account to a supplier we code the payment to the relevant account in the general ledger receiving an invoice is also an accounting trigger when using accounting software like QuickBooks Online you are required to enter the details from the invoice into your accounts payable ledger once you've received it I'll explain how this works later in the example okay why does all of this matter my point is that we have to accounting triggers the invoice and the payment if both of these are going to happen later in the future then right now in the present we've got a problem we have no accounting triggers to record the goods or services when we received them in the past that's when the substance of the transaction took place that's when the expense was incurred and accrual accounting is telling us that we need to record the transaction here but how do we go about accruing an expense in the past I'll show you right now let's imagine that we own a business and there are some basic overhead costs associated with running our office things like electricity heating and water we call these utility expenses and for now let's focus on water in our office we are built for our water usage on a quarterly basis four times a year and on each occasion the bill covers our water consumption for the previous three months today is November first the first day of a new billing cycle that means that three months from now on the 31st of January will receive a water bill covering 3 months November December and January 3 accounting periods and to keep things simple let's assume that water normally costs us about $50 per month let's jump forward now to November 30th one month has passed and it's the end of an accounting period do we have any adjusting entries to post yes we do we've been using water for a whole month we haven't received a bill or paid for any of that consumption yet so we need to accrue an expense into our general ledger and how do we do that we post a journal entry we need to recognize a utilities expense in our income statement water normally costs us $50 per month so we need to increase our utility expenses by $50 expenses are the first e in dealer normal debit accounts so debits increase them and credits decrease them all utility expenses need to go up so we debit our utilities expense account by $50 but where does the other side of this transaction go we are double entry accounting so there is another side to this adjusting journal entry we've already hit expenses in our income statement so we need to temporarily hold the other side of this journal entry somewhere in our balance sheet in our accrued expenses account but our accrued expenses an asset or a liability let's work it out assets bring us future economic benefit whereas liabilities involve a future economic sacrifice we've already received economic benefit from this transaction because we've been using water for the past month but we haven't paid for it yet at the present moment we are committed to making a future economic sacrifice so we have to recognize an accrued expense as a liability in the balance sheet accrued expenses are always recorded as liabilities in the balance sheet and liabilities are the L in dealer normal credit accounts so credits increase accrued expenses and debits decrease them so we need to credit our accrued expenses to increase them by $50 in the balance sheet great let's see how this adjusting journal entry affects our general ledger using T accounts we have two T accounts the utilities expense account in the income statement and accrued expenses in the balance sheet remember when using T accounts debits always go on the left and credits always go on the right we debit the left-hand side of the utilities expense account by $50 and we credit the right-hand side of accrued expenses in the balance sheet by $50 so we have accrued the utilities expense of $50 in our income statement for November now let's jump forward to the end of December another month has flown by do we have any more adjusting entries to post yes we do we've consumed another months worth of water and we still haven't received a bill or pay for any of it yet we need to accrue some more utility expenses the journal entry looks like this it's exactly the same as the one we posted last month why because we estimated the water costs us roughly $50 per month so we need to recognize another $50 of utility expenses in December and on the flip side we need to increase our accrued expenses in the balance sheet by another $50 and how does this impact our books like this our utility expenses now come to $100 50 of which was expensed in November and another 50 in December in our balance sheet we are now carrying accrued expenses of $100 this liability keeps getting bigger because we've now gone two months without an accounting trigger to settle this once and for all we haven't received a bill or a payment in November or December so we are making our best estimate of what the bill might be at this stage okay now we'll jump forward to the end of January the final month of our quarterly billing cycle the water company has sent us an invoice covering the past three months and it comes to 153 dollars so it's not bang on the one hundred and fifty dollars that we expected but that's okay we used our best estimate and we actually came in pretty close like I mentioned before I like to think of invoices as accounting triggers here's what I meant by that when we entered this invoice into QuickBooks Online or whatever accounting software you're using we need to categorize the transaction and when we do this it automatically triggers a journal entry that gets posted behind the scenes in our general ledger if you run a business and receive lots of invoices then this automatic posting can become a huge time saver and it's one of the many benefits of using accounting software I'll pop a link down in the description to a free trial of QuickBooks Online so you can test it for yourself it's an affiliate link so by signing up you'll have the opportunity to support me making more accounting tutorials just like this one the automatic journal entry looks like this it debits our utilities expense account by one hundred and fifty three dollars to increase our expenses the other side of this journal entry is going to credit our accounts payable account by one hundred and fifty three dollars in the balance sheet I just want to point out to this moment that we haven't actually paid our water bill yet we have only received the bill and now we have 30 days in order to make the payment we owe money to the water supplier so we have a liability in our balance sheet how does this affect our general ledger we need to credit a new t account accounts payable on the balance sheet by one hundred and fifty three dollars that's the final balance of what we owe to the supplier and we debit utilities expense account in the income statement by one hundred and fifty three dollars but hang on our utility expenses are now two hundred and fifty three dollars that's quite high our final bill was only one hundred and fifty three dollars how does any of this make sense we accrued fifty dollars of utility expenses in November and another fifty dollars in December when we add the one hundred and fifty three dollars that was automatically journals in January we get two hundred and fifty three dollars both our expenses in the income statement and our liabilities in the balance sheet are overstated by one hundred dollars that's because we have one more adjusting journal entry to post we need to release our food expenses from the balance sheet so let's do that the journal entry looks like this we need to reduce our accrued expenses in the balance sheet accrued expenses are liabilities so we reduce them by debiting the account by $100 our utilities expense account an income statement is also overstated this is a normal debit account so to decrease it we credit the utilities expense account by $100 we post this journal entry into the January accounting period debiting the left-hand side of accrued expenses in the balance sheet by $100 and crediting the right-hand side of the utilities expense account in the income statement by $100 when we close off the quarter we have incurred utility expenses of one hundred and fifty three dollars in our income statement $50 which we accrued in November another 50 in December and then in January we took up a further fifty three dollars there are no more accrued expenses in our balance sheet because we released our $100 accrual in January and we now owe one hundred and fifty three dollars to our water supplier which we recognize as a liability in accounts payable we've recorded all of our expenses in the correct periods as we incurred them so our books are in line with the accrual basis of accounting in the next video we'll round off this adjusting entries miniseries with a video on accrued revenue click on this circle to subscribe so you don't miss out on that and the whole playlist can be found over here as always if you've got any questions let me know down below in the comments or message me directly on instagram at accounting stuff see ya

Channel: Accounting Stuff

Views: 270,980

Keywords: accounting, accrued expenses, unbilled expenses, adjusting entries, journal entries, adjusting entry, how to accrue expenses, accrue, accrual, accounting tutorial, accounting basics, financial accounting, t account, accrual accounting, adjusting journal entry, accrual basis, accrual method, income statement, balance sheet

Id: 9aZ6CCj-ies

Length: 12min 54sec (774 seconds)

Published: Mon Jul 01 2019