Resources | Subject Notes | Accounting
This section covers the accounting treatment of accrued expenses and prepaid expenses. Understanding these concepts is crucial for accurately reflecting a business's financial position and performance.
Accrued expenses are expenses that have been incurred but not yet paid. They represent a liability to the business.
Consider a business that receives an electricity bill at the end of the month. The electricity was used throughout the month, but the bill hasn't been paid yet. This unpaid bill is an accrued expense.
To record an accrued expense, a journal entry is made with a debit to the relevant expense account and a credit to the corresponding payable account.
The general format of the journal entry is:
Debit: Expense Account (e.g., Salaries Expense, Rent Expense) Credit: Creditor's Account (e.g., Salaries Payable, Rent Payable)
The accrued expense will be recorded in the ledger account of the expense being accrued.
The corresponding payable account will be updated to reflect the amount owed.
Example: Salaries incurred but not yet paid - $2,500
| Date | Account | Debit | Credit |
|---|---|---|---|
| 2024-07-31 | Salaries Expense | $2,500 | |
| 2024-07-31 | Salaries Payable | $2,500 |
Salaries Expense Ledger Account:
| Date | Description | Debit | Credit | Balance |
|---|---|---|---|---|
| 2024-07-31 | To Salaries Payable | $2,500 | $2,500 |
Prepaid expenses are expenses that have been paid in advance but have not yet been incurred. They represent an asset to the business.
A business might pay for insurance coverage for the next six months at the beginning of the period. The insurance premium has been paid, but the benefit (the insurance coverage) is received over the following six months. This prepaid insurance is an asset.
To record a prepaid expense, a journal entry is made with a debit to the prepaid expense account and a credit to the cash account.
The general format of the journal entry is:
Debit: Prepaid Expense Account (e.g., Insurance Premium, Rent Premium) Credit: Cash Account
At the end of the accounting period, an adjustment is made to recognize the expense as it is incurred. This involves a journal entry with a debit to the expense account and a credit to the prepaid expense account.
Example: Prepaid Insurance Premium - $1,200
| Date | Account | Debit | Credit |
|---|---|---|---|
| 2024-07-01 | Prepaid Insurance Premium | $1,200 | |
| 2024-07-01 | Cash | $1,200 |
Prepaid Insurance Premium Ledger Account:
| Date | Description | Debit | Credit | Balance |
|---|---|---|---|---|
| 2024-07-01 | To Cash | $1,200 | $1,200 | |
| 2024-07-31 | To Insurance Expense | $200 | $1,000 |
Accrued and prepaid expenses are important concepts in accounting. Accrued expenses represent liabilities, while prepaid expenses represent assets. Correctly recording these transactions ensures that the financial statements accurately reflect the business's financial position and performance.