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Accrued Liabilities (Accrued Expenses) in Financial Accounting
As we noted earlier, a key reason for making adjusting entries at the end of an accounting period is to recognize liabilities that are not already in the accounting records. This practice applies to any type of liability. As you will see, accrued liabilities (also called accrued expenses) can include estimated liabilities.
Here, we focus on interest payable, a definitely determinable liability. Interest accrues daily on interest-bearing notes. In accordance with the matching rule, an adjusting entry is made at the end of each accounting period to record the interest obligation up to that point.
Current liabilities of an assumed corporation listed in figure 7.1 in "Types of Current Liabilities" include $710.1 million in accrued compensation and benefits. Accrued liabilities represent expenses that have been incurred prior to the balance sheet date but have not been paid nor included with liabilities as of the balance sheet date. An adjustment must be made to recognize the expense and the related obligation at the balance sheet date. (To make things easier we are going to name the corporation "XYZ" for the sake of it)
XYZ's accrued compensation benefits consist primarily of (1) wages and salaries earned, though unpaid, at the balance sheet date and (2) vacation and holiday pay. To illustrate an adjustment to recognize accrued wages and salaries, assume that XYZ has a weekly payroll of $400 million, and that XYZ's balance sheet date of September 30, 2000, falls on a Tuesday. In such a situation, XYZ’s employees have earned two days’pay, or $160 million (2 days / 5 days = 40%; $400 million weekly payroll * 40% = $160 million) as of the balance sheet date. If so, it is necessary for XYZ to accrue the expense and liability as of September 30, 2000:
As a result, $160 million of compensation expense would be recognized in 2000, and the current liabilities reported at September 30, 2000, would include an accrued liability for this amount. When the weekly payroll ($400 million) is paid to the employees on October 3, 2000, the following balance sheet effects occur:
Note that this accrual of compensation expense is used to achieve the objective of matching costs and benefits that was discussed earlier (especially in Chapter, “The Basic Concepts of Financial Accounting,”and Chapter, “The Income Statement”). The total compensation expense of $400 million has been appropriately divided between the fiscal years ending on September 30 of 2000 and 2001 in proportion to the benefits obtained each year.
To illustrate the accrual of vacation benefits, assume that XYZ’s employees earn vacation benefits evenly over the period July 1 through June 30, and the firm incurs total vacation expenses each year of $2 billion. In this case, at the balance sheet date of September 30, 2000, XYZ’s employees would have earned three months (July, August, and September) of vacation benefits, or $500 million (3 months / 12 months = 25%; $2 billion annual expense * 25% = $500 million). For this reason, XYZ’s 2000 income statement would include an expense and the balance sheet at September 30, 2000, would include a current liability for accrued employee benefits of $500 million.
Current Liabilities Topics
Managing Liquidity and Cash Flows
- Accounts payable
- Discounts in Current Liabilities
- Notes Payable
- Accrued Liabilities (Accrued Expenses)
- Current Maturities/Portion of Long-Term Debt
- Taxes Payable
- Accrued Restructuring Costs
- Advance Payments from Customers
- Obligations for Warranties
Commitments, Contingencies and Risks
