Here's the rule. If a company incurred, used, or consumed all or part of an expsense, that expense of part of it should be properly recognized even if it has not yet been paid.
If such has not been recognized, then an adjusting entry is necessary.
The pro-forma entry for accrued expense is:
|Payable account (liability)**||x,xxx.xx|
*Appropriate expense account such as Utilities Expense, Rent Expense, Interest Expense...
**Payable account (Utilities Payable, Rent Payable, Interest Payable, Account Payable, etc.)
For the month of December 2012, Gray Network Services used a total of $1,800 worth of electricity and water. The company received the bills on January 10, 2013. When should the expense be recorded, December 2012 or January 2013?
Answer -- in December 2012. According to the expense recognition principle, expenses are recognized when incurred regardless of when paid. The amount above pertains to utilities used in December. Therefore, if no entry was made for this expense in December then an adjusting entry is necessary.
In the adjusting entry above, Utilities Expense is debited to recognize the expense and Utilities Payable to record a liability since the amount is yet to be paid.
Here are some more examples.
More Examples: Adjusting Entries for Accrued Expense
Example 1: VIRON Company enters into a rental agreement to use the premises of DON's building. The terms state that VIRON will pay monthly rentals of $1,500 at the end of every month. The lease started on August 1, 2011. On August 31, the rent for the month has not yet been paid and no record for rent expense was made.
In this case, VIRON Company already incurred (consumed/used) the expense. Even if it has not yet been paid, it should be recorded as an expense. The necessary adjusting entry would be:
Example 2: VIRON Company borrowed $6,000 at 12% interest on August 1, 2011. The amount will be paid after 1 year. At the end of December, the end of the accounting period, no entry was entered in the journal to take up the interest.
Let's analyze the above transaction.
VIRON will be paying $6,000 principal plus $720 interest after a year. The $720 interest covers 1 year. At the end of December, a part of that is already incurred, i.e. $720 x 5/12 or $300. That pertains to interest for 5 months, from August 1 to December 31. The adjusting entry would be:
An expense is recognized when it is incurred regardless of when it is paid. What you need to remember here is this: when it has been consumed or used and no entry was made to record an expense, then there is a need for an adjusting entry.