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When to post an expense accrual – Transcript
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- An expense accrual is posted in the month the service work is performed and expenses are incurred, even if the invoice has not yet been received.
- In February, maintenance expense is debited for fifteen hundred dollars and accrued expenses is credited for fifteen hundred dollars based on available information.
- When the invoice arrives in March, the accrual entry is reversed and the actual invoice is recorded with accounts payable and maintenance expense.
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Let’s work through an example of when to post an expense accrual. We are getting some maintenance work done.If… in January, we issue the Purchase Order (in short PO).Then in February, we get the maintenance work performed.In March, we receive the invoice.
And in April, we pay the invoice to the supplier.Then in which month do we record the expenses, in other words post the expense accrual to the general ledger? The answer is: February. That’s when the actual service work is performed, and that’s where the expenses belong. This brings us to the definition of an expense accrual: expenses have been incurred, for which we have not yet received an invoice from the supplier,
so we “put money aside” as we know the invoice will come at a later stage. Now that we have figured out that we need to make the expense accrual in February, how much money do we need to accrue?When the purchase order was issued, we expected the maintenance work to take forty hours, and the rate per hour to be fifty dollars (for a senior engineer), which makes for a total amount of two thousand dollars.
When the work was performed, we signed off on timesheets for thirty hours, expected the rate per hour to be fifty dollars (per the information in the purchase order), which makes for a total amount of fifteen hundred dollars.When the invoice was received and subsequently paid, we found out two pieces of good news: only thirty hours were spent, at an hourly rate of only forty dollars per hour (for a junior engineer), which makes
for a total amount of twelve hundred dollars.How much do we accrue in the month of February? Fifteen hundred dollars. This is the most accurate information we have at that time. In March, we found out, based on new information in the invoice, that the actual cost was only twelve hundred dollars. With the benefit of hindsight, we overaccrued in February. Yet
another example of "Life can only be understood backwards; but it must be lived forwards." Let’s work through the journal entries by month, in order to see how the expense accrual fits into the accounting process. In January, when the purchase order is issued, no journal entry is needed. In February, based on the information we have at that time, we use an expense accrual to
put money aside for later, as we know the invoice will come in someday. We need two general ledger accounts to post the accrual: maintenance expense in the income statement or P&L, and accrued expenses, a liability account on the balance sheet. Debit maintenance expense for fifteen hundred dollars, credit accrued expenses for fifteen hundred dollars.
When the invoice is received in March, we need to do two things. First, reverse the accrual journal entry. Reversing a journal entry means you cancel it out, by booking the opposite of what you booked before. Credit maintenance expense in the income statement for fifteen hundred dollars, debit accrued expenses on the balance sheet for fifteen hundred dollars.
Second, we record the invoice which has now been received. The balance sheet part of this journal entry goes to accounts payable, NOT to accrued expenses. Accounts payable is a balance sheet liability account where we post amounts related to invoices that we have received from suppliers, but not paid yet. Accrued expenses is the balance sheet liability account where we post amounts
related to outside work that has been performed for us, but not yet invoiced by the supplier. Debit maintenance expense for twelve hundred dollars, credit accounts payable for twelve hundred dollars.The maintenance expense account is impacted by both journal entries. For the month of March, a “net credit” of three hundred dollars remains: fifteen hundred dollars minus twelve hundred dollars, which is a net “negative cost”
(or “gain”) in the P&L. Expenses increase with a debit, and decrease with a credit. The accrual we made in February was too high, we now correct it in the subsequent month of March to get to the correct amount on a year-to-date basis. The books are already closed for February, so this adjustment is booked in the next available month that is open in the general ledger.
And then in April, we have the balance-sheet-to-balance-sheet journal entry of debiting accounts payable, and crediting cash. No expense impact in the income statement in April, just a balance sheet entry that decreases both what we own (as cash is an asset) as well as what we owe (as accounts payable is a liability).
That’s all there is to it! Post an expense accrual in the general ledger, when expenses have been incurred, for which we have not yet received an invoice from the supplier.