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5.7. Accruals

Another type of adjusting journal entry pertains to the "accrual" of unrecorded expenses and revenues. Accruals are expenses and revenues that gradually accumulate throughout an accounting period. Accrued expenses relate to such things as salaries, interest, rent, utilities, and so forth. Accrued revenues might relate to such events as client services that are based on hours worked. Because of their importance, several examples follow.

5.8. Accrued Salaries

Few, if any, businesses have daily payroll. Typically, businesses will pay employees once or twice per month. Suppose a business has employees that collectively earn $1,000 per day. The last payday occurred on December 26, as shown in the 20x8 calendar at right below. Employees worked three days the following week, but would not be paid for this time until January 9, 20x9. As of the end of the accounting period, the company owes employees $3,000 (pertaining to December 29, 30, and 31). As a result, the adjusting entry to record the accrued payroll would appear as follows:

12-31-X8

Salaries Expense

3,000

Salaries Payable

3,000

To record accrued salaries

The above entry records the $3,000 of expense for services rendered by the employees to the company during year 20x8, and establishes the liability for amounts that have accumulated and will be included in the next round of paychecks.

Before moving on to the next topic, you should also consider the entry that will be needed on the next payday (January 9, 20x9). Suppose the total payroll on that date is $10,000 ($3,000 relating to the prior year (20x8) and another $7,000 for an additional seven days in 20x9). The journal entry on the actual payday needs to reflect that the $10,000 is partially for expense and partially to extinguish a previously established liability:

1-9-X9

Salaries Expense

7,000

Salaries Payable

3,000

Cash

10,000

To record payment of payroll relating to two separate accounting periods

You should carefully note that the above process assigns the correct amount of expense to each of the affected accounting years (regardless of the moment of payment). In other words, $3,000 is expensed in 20x8 and $7,000 is expensed in 20x9.

5.9. Accrued Interest

Most loans include charges for interest. Interest charges are usually based on agreed rates, such as 6% per year. The amount of interest therefore depends on the amount of the borrowing ("principal"), the interest rate ("rate"), and the length of the borrowing period ("time"). The total amount of interest on a loan is calculated as Principal x Rate x Time. For example, if $100,000 is borrowed at 6% per year for 18 months, the total interest will amount to $9,000 ($100,000 x 6% x 1.5 years). However, even if the interest is not payable until the end of the loan, it is still logical and appropriate to "accrue" the interest as time passes. This is necessary to assign the correct interest cost to each accounting period. Assume that our 18 month loan was taken out on July 1, 20x1, and was due on December 31, 20x2. The accounting for the loan on the various dates (assume a December year end, with an appropriate year-end adjusting entry for the accrued interest) would be as follows:

20X1

7-1-X1

Cash

100,000

Loan Payable

100,000

To record the borrowing of $100,000 at 6% per annum; principal and interest due on 12-31-X2

12-31-X1

Interest Expense

3,000

Interest Payable

3,000

To record accrued interest for 6 months

($100,000 X 6% X 6/12)

20X2

12-31-X2

Interest Expense

6,000

Interest Payable

3,000

Loan Payable

100,000

Cash

109,000

To record repayment of loan and interest (note that $3,000 of the total interest was previously accrued)

In reviewing the above entries, it is important to note that the loan benefited 20x1 for six months, hence $3,000 of the total interest was expensed in 20x1. The loan benefited 20x2 for twelve months, and twice as much interest expense was recorded in 20x2.

 
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