Accrued Expenses
   

There are two type of transactions in which a cash disbursement and the related expense occur in different accounting periods:

·The cash disbursement is made prior to the incurrence of expense. At the time cash is paid out, an asset, Prepaid Expense, is created.  
·The cash disbursement is made after the expense is incurred. At the time the expense is incurred, a liability, called Accrued Liability, is created.  
 
Prepaid Expenses:

Assume that in January, Art Supplies Ltd. paid €900 cash for a supply of heating oil that it will use in heating its premises for the next several months. In January, Cash decreases by €900 and there is an equal increase in an asset, Heating Oil Inventory. In January there was no decrease in equity and no expense. The entry for January would be as follows:

Dr. Heating Oil Inventory  
€900

Cr. Cash  

€900
 
(From here on, the abbreviations Dr. and Cr. are used for Debit and Credit.)  

The expense occurs in the months when the heating oil is used. Assume that €400 of oil was used in February, €300 in March, and €200 in April. These amounts are expenses in those months, and the Heating Oil Inventory account decreases by an equal amount. The entry for February is as follows:

Dr. Heating Oil Expense  
€400

Cr. Heating Oil Inventory  

€400
 
 
Each month you enter a credit to the asset account and a debit to Heating Oil Expense. The effect on the balance sheet and on the income statement in each month is as follows:


Expense
Residual Asset Value
January
€ 0
€ 900
February
€ 400
€ 500
March
€ 300
€ 200
April
€ 200
€ 0
 
 
The same principle applies to any asset used in future periods. The purchase of insurance protection creates an asset, Prepaid Insurance. As the insurance protection expires, there is a credit to Prepaid Insurance and a debit to Insurance Expense. The advance payment of rent creates an asset, Prepaid Rent. In the period that the rent covers, there is a credit to Prepaid Rent and a debit to Rent Expense.

Buildings, equipment, furniture and other long-lived assets also become expenses over future periods and are accounted for in essentially the same way as the heating oil. However, the details for recording long-lived assets are somewhat different and are described later.

 
Accrued Liabilities:

If you incur an expense prior to the period in which the cash is paid, a liability is created at that time. For example, if employees earn €1,000 in January but are not paid until February, the entity has an expense of
1,000 in January and a liability, Accrued Salaries, at the end of January. In February, when employees are paid, there is a 1,000 credit to Cash and a 1,000 debit to Accrued Salaries. The debit part of the entry cancels the liability. The entries are:
 
In January:

Dr. Salaries/Payroll Expense  
€1,000

Cr. Accrued Salaries  

€1,000
 
 
In February:

Dr. Accrued Salaries  
€1,000

Cr. Cash  

€1,000
 

Accrued Revenues:


Like expenses, revenues are not necessarily earned in the period in which the related cash is received. The entity can earn revenues prior to, in the same period as, or after the period in which the cash is received. If revenue is earned in the same period, as with a sale of goods for cash, the entry is simply a debit to Cash and a credit to Sales Revenue. The other two possibilities require use of the accrual principle.

Deferred Revenue:

Some landlords collect rent from their tenants in advance. If rent received in January applies to the use of property in February, the revenue is earned in February, not January. In January, when the entity receives cash, the credit offsetting the debit to Cash is to a liability account, Deferred Rent. This account reports the entity's obligation to provide the tenant with the use of the property in February. The entries for rent of €600 received in January and applied to the use of property in February are as follows:

In January:      

Dr. Cash  
€600

Cr. Deferred Rent  

€600
 

In February:

Dr. Deferred rent  
€600

Cr. Rental Revenue  

€600