Definition of Accrued Salaries
Accrued Salaries are defined as the current liabilities at the end of a given financial period for salaries and/or payroll expenses that have been incurred by the company, but are not yet paid for by the Company.
The accrued salaries are debited in the salaries account of the income statement and subsequently credited as Current Liabilities in the balance sheet of the company. Accrued Salaries are treated as a current liability because organizations need to settle this particular expense in the forthcoming future. Hence, it is categorized as a short-term liability on the financial statements.
Explanation of Accrued Salaries
Accruals, as well as deferrals, tend to be the basis of the accrual method of accounting. Under this premise, the accountant is supposed to make the due adjustments for revenues that have been earned, but not yet received, as well as expenses that have been incurred, but not yet recorded.
All the accruals that are incurred by the business are made using adjusting journal entries, at the end of the respective accounting period.
During the normal course of business, there are several different transactions that take place at different timelines. However, under the accrual basis of accounting (and the matching principle), all expenses that have been incurred in a given fiscal year are supposed to be recorded in the financial statements of the company.
Expenses that are incurred over the course of time, but are not yet paid for are referred to as Accrued Expenses. By this definition, accrued expenses are expenses that are incurred by the company, but are not yet paid for.
These are salaries that the organization needs to pay to their employees, but they are not yet paid for by the company. Therefore, salaries that have been incurred, but are not yet paid for are referred to as accrued salaries.
Since accrued salaries are short-term obligations that the company needs to pay for, they are accounted as current liabilities on the balance sheet of the company.
The concept of accruals, in general, is tantamount to the accuracy, as well as reliability of the financial statements. This is because, under cash-based accounting, the actual profitability of the organization is not accounted for.
Accountants are only supposed to record cash-based transactions, and hence the actual profitability of the company might be compromised upon. Therefore, accrual-based accounting tends to be highly important and realistic in terms of ensuring that the users of the financial statements get a true and fair idea regarding the actual financial position of the company.
Journal Entry of Accrued Salaries
As mentioned earlier, accrued salaries are treated as Current Liabilities, since these are short-term obligations for expenses that have actually been incurred by the organization. During the normal course of business, when companies incur (and pay salaries), the following journal entries are made:
On the contrary, in case there are salaries accrued by the company, they are treated as follows:
These accrued salaries are also mentioned as Current Liabilities on the Balance Sheet of the company:
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Once the organization settles these liabilities, then the following journal entries are carried out:
It is important to understand that the ideology behind this treatment is vested on the grounds of the matching principle, which requires expenses to be matched with revenues for the particular period.
Therefore, salaries, regardless of being paid for or not, are recorded as incurred expenses on the Income Statement for the particular year. Given the fact that the amount for salaries has not been paid via bank, the corresponding credit is then made to the Accrued Salaries Account.
Example of Accrued Salaries
The concept of accrued salaries is illustrated in the following example:
Brings Inc. is a retail outlet based in Penang. For the year ended 31st December 2021, they had total salaries amounting to $1,000,000. For the month ended 31st December 2020, they had salaries worth $75,000. Under the normal business practice, Brings Inc. settles all salaries by the 10th of the following month.
In the example above, it can be seen that Brings Inc. had a total payroll expense amounting to $1,000,000 for the year ended. This expense was actually incurred by the company, and therefore, it is going to be declared in full in the financial statements, regardless of the amount not yet paid by the company.
However, the outstanding amount for salaries for the month of December 2021 is not yet paid, and hence, they are going to be regarded as accrued salaries, under the current liabilities section of the Balance Sheet.
For Brings Inc. the following journal entries are going to be made at the end of December 2021. They are as follows:
Accrued Salaries of $75,000 will subsequently be mentioned as Current Liabilities on the Balance Sheet. On 10th January 2021, once the salaries are settled, the following journal entries will be made:
How do Accrued Salaries impact the Financial Statements?
Accrued Salaries are payroll expenses that have been incurred by the company, but are not yet paid for. Since accrued salaries are current liabilities, they are accounted for in the financial statements as follows:
- Impact of Accrued Salaries on Income Statement: As far as income statement is concerned, it is not impacted by accrued salaries. This is because salary expenses that has been incurred is mentioned as it is in the expenses of the company. Hence, there is no impact on the Income Statement of the company.
- Impact of Accrued Salaries in the Balance Sheet: As far Balance Sheet is concerned, it is impacted by accrued salaries. The amount of accrued salaries are mentioned as current liabilities in the Balance Sheet. The net effect, however, of accrued salaries is null. This is because had these salaries been settled, it would have resulted in a credit entry in the bank (since the bank balance would have decreased). Since salaries have not yet been paid for, in that case, Current Liabilities would increase. Therefore, the net impact of Accrued Salaries in the Balance Sheet is zero. The only difference is the categorization of these accrued expenses.
Importance of Calculating Accrued Salaries
As mentioned earlier, the accrual basis of accounting is resourceful because it helps organizations to get a more accurate picture regarding the financial position of the company.
In this regard, it is important to ensure that companies keep a proper record of accrued expenses so that they know their obligations, as well as their incurred expenses over the course of the financial year.
Therefore, keeping a strong tab on accrued salaries is highly important, because it helps users of the financial statements to know the actual current liabilities of the business, as well as the total expense for the given year.
Regardless of the fact that it might not impact the financial position of the company (in terms of profitability, or Total Net Assets), yet proper categorization of accrued salaries is an important phenomenon that cannot be ignored by accountants.