There are many specialties in the Accounts Payable arena, and accrued expense accounting is an important one.
An accrued expense differs from an ordinary present-and-pay invoice from a vendor because of its complexity and total time frame involved in the debt. Accrued expense is recognized before a bill is paid-not when it’s paid–requiring computation of correct interest rates.
Generally, accrued expenses do not include recurring expenses-those that present an invoice repeatedly and encompass a known quantity, schedule of delivery, or other regularly occurring debts. A utility bill, for example, is a recurring expense but not an accrued expense when paid in full each month.
A working definition of accrued expense can be “additional monies owed from accumulated interest and/or penalties on a long-term, outstanding balance.” Therefore, accrued expenses apply to such financial liabilities as bank loans and mortgages-interest-bearing debts paid over several months or years.
Accrued Expense Scenario
For example, a business assumes a loan debt of $100,000 to be paid in monthly installments and accrues annual interest of five percent. Each month, AP notes the installment amount due, $1000.00. But that is not the total to be paid that month because of the interest rate. Five percent of the outstanding loan balance for the first year is $5000.00. Over one year, that interest is paid in monthly installments, as well. $5000 divided by twelve months equals $416.67 per month in interest. The total amount paid that month includes both the base installment plus the interest payment: $1416.67.
The base installment is incurred and paid regularly and is, therefore, a recurring expense. The interest paid monthly is an accrued expense. Both involve the same debt: the bank loan, but the $416.67 arises because of the debt-not because it is the debt.
The accrued expense is carried in the business’ financial records as a liability and noted separately than one-time or recurring expenses on the balance sheet until the base debt is fully paid.
Because of the decreasing total interest each year, the accrued interest must be continually recomputed and verified. As each base installment reduces the annual base debt, the accrued interest also declines. The Accounts Payable department still notes the accrued interest as a liability, the amount will change over the course of the debt repayment.
Hungry Minds, Inc. “Accounting for Dummies,” ©2001. John A. Tracy, CPA; p129-130.
John Wiley & Sons, “Wiley GAAP 2010: Interpretation and Application of Generally Accepted Accounting Principles,” ©2009. Barry J. Epstein, Ralph Nach, and Steven M. Bragg; p741-790.
Southwestern Publishing Company, ©2002; Carl S. Warren, James M. Reeve, Jonathon Duchac; p. 133-180; appendix A2.