The accrual system of accounting is based on a fundamental notion that expenses must be recorded and recognized in the period in which they were incurred. This is often referred to as the matching principle, and it creates the need for an accrued expense account for expenses that have been incurred but not paid out. At the end of the accounting period, accrued expense accounts are reconciled based on the actual amount received.

Recording the Entry

An accrued expense is originally recorded with a debit and a credit to the corresponding expense account payable. In general, the entry should be recorded as follows:

Debit Accrued Expenses to the Income Statement Credit Expenses Payable to the Balance Sheet

The Reconciliation Process

The balance sheet equation is: assets = liabilities + stockholders' equity. If the equation doesn't balance, the accounting for the business is off. The process of balancing this equation is referred to as account reconciliation. The most common reconciliations stem from accruals and deferrals; a deferral is the opposite of an accrual. A reconciliation for accrued expenses is the reverse of the original journal entry.

Accrued Expenses Example

As an example, assume your business takes out a loan at the beginning of the year and owes $1,000 as interest on that loan. For accounting purposes, the interest paid on the loan must go against sales received in the current accounting period, even though the interest isn't paid until Jan. 5 of the following calendar year. Your business will need to make a journal entry recording the interest expense of $1,000 in the year the loan funds were used; because interest expense isn't paid out until the following year, it creates the need for an accrued interest expense.

Reconciling Journal Entries

To record the accrued expense, the following entry is made:

Debit Interest Expense 1,000
Credit Accrued Interest Expense Payable 1,000

When the payment is actually made in the following year, the following reconciliation is recorded to account for the payment:

Debit Accrued Interest Expense Payable 1,000
Credit Cash 1,000

This reconciliation removes the payable and transfers the balance to cash on the balance sheet.