2.17 Accrued Expenses Example

Accrued Expenses: Desert Inc. Example

Concept: Accruals Before Cash (ABCD)

  • Relates to the timing of expense recognition versus cash payment.

Problem Setup

  • Desert Inc. pays employee wages of 1,5001,500 per week for a five-day workweek (Monday to Friday).
  • December 31st is a Tuesday and the company's fiscal year-end.
  • Task: Record the year-end adjusting journal entry and the entry on January 3rd (payday).

Timeline

  • Crucial for visualizing the accrual.
  • Monday, December 30th: Workweek begins.
  • Tuesday, December 31st: Year-end.
  • Wednesday, January 1st.
  • Thursday, January 2nd.
  • Friday, January 3rd: End of week and payday.

Calculation of Daily Wage

  • 1,500 / 5 \, \text{days} = $300 \text{ per day}

Adjusting Journal Entry at Year-End (December 31st)

  • Employees have worked two days (Monday and Tuesday) but won't be paid until the next fiscal year.
  • Desert needs to recognize the wage expense incurred in the current year.
Accounts
  • Debit: Wage Expense
  • Credit: Wages Payable
Reasoning
  • No cash changes hands yet.
  • Expense is incurred as employees worked.
  • Matching Principle: Expenses are matched with revenues in the period they help generate revenue.
Calculation of Expense
  • 2 days×2 \,\text{days} \times300 \,\text{per day} = 600600
Wages Payable
  • Represents the amount owed to employees.
  • It is a liability: a probable future economic sacrifice.
  • Liabilities have a normal credit balance, so a credit increases the balance.
Adjusting Entry
  • Debit Wage Expense: 600600
  • Credit Wages Payable: 600600

Journal Entry on Payday (January 3rd)

  • Employees are paid, so cash is involved.
  • Payable is settled, and additional days of work need to be recorded as an expense.
Accounts
  • Debit: Wage Expense (for the three days in the new year)
  • Debit: Wages Payable (to close out the payable from the prior year)
  • Credit: Cash
Wage Expense Calculation for New Year
  • 3 days×3 \,\text{days} \times300 \,\text{per day} = 900900
  • Debit wage expense to increase it (expenses have a normal debit balance).
Wages Payable
  • Debit wages payable to decrease the liability account (normal debit balance).
Cash
  • Credit cash to represent the cash outflow (assets have a normal debit balance).
Payday Entry
  • Debit Wage Expense: 900900
  • Debit Wages Payable: 600600
  • Credit Cash: 1,5001,500

Summary

  • Accrued expense: Expense incurred in one period, but cash payment occurs in a later period.
  • In the first fiscal year, the expense is incurred, but not yet paid.
  • In the second fiscal year, cash is paid, the payable is closed out, and the additional expense is recorded.