Accrued Expenses Meaning Explained With Examples of Accrued Expenses & Importance

Interest recorded in the Income Statement represents the interest accrued during the period covered by the financial statements; not the amount of interest paid over that period. Interest income, on the other hand, is the revenue earned by an entity for lending their funds or letting others to use entity’s resources. Both these items are separate line item in company’s financial statement and therefore, should be disclosed separately for each period. Despite the possibility of distribution of profit not actually earned, accrual basis of accounting is generally followed because of its logical superiority over cash basis of accounting. Section 209 of the Companies Act makes it mandatory for companies to maintain accounts on accrual basis only.

In the other words, this is the additional funds available with the organization kept reserved for specific future requirements. Suppose you are a firm M/S ABC Pvt Ltd, and you are using accrual accounting to maintain your books of accounts. Here, any revenue or income which is generated by sales and expenses incurred are recorded as they occur. Under the ‘Accrual’ based accounting, transactions are recognised as soon as they occur, whether or not cash or cash equivalent is actually received/ paid or not. Profit/ loss calculated based on accruals, reflects activities of the enterprise during an accounting period, rather than cash flows generated by it.

In the absence of any identifiable payee or the quantification of the duly ascertained amount of the liability, the provisions of TDS could not be made applicable. Thus, to be brief and explicit, if no income is attributable to the payee, there is no liability on the part of the Company to deduct tax at source on such year-end provisions of expenses. The assessee contended that since the names of payees were not known, the TDS was not deducted as the assessee did not know in whose account the TDS was to be credited. Further, the assessee claimed that making a provision on an estimate basis on the sales effected by the assessee, becomes an ascertained liability and thus was allowable as business expenditure. Further the entire provision has been written back in the next year and the actual amounts paid/credited were subjected to TDS as per the detailed statements filed before the authorities on which there is no dispute.

Going Concern: #1 Fundamental Accounting Assumption

We have heard both the parties and have gone through the orders of the authorities below. CIT has further noted that this accounting method followed by the assessee was in consonance with the prescribed Accounting Standard and policy in accordance with the Prudence norms. That it complied accordingly with section 145 of the Act requiring income to be computed in accordance with notified accounting standards. The Tribunal held that the assessee had claimed these expenses by debiting into the profit and loss account, it needed to deduct TDS on such expenditure, even if not credited to respective parties account.

In this case, the assessee made a provision of certain expenses in respect of payment due to various parties but did not deduct TDS thereon. Next year the entire provision of expenses was written back and the actual amounts paid to the respective parties were credited to their respective accounts and TDS as per the provisions are being made. This decision was rendered on the exclusive and peculiar facts of the case. In accrual-based accounting, accruals refer to expenditures and revenues incurred or earned but not recorded in account books. Adjustment entries to report these at the end of an accounting period are incorporated in the financial statements.

At last, Section 145 of the Income Tax Act, 1961 prescribes the method of accounting to be followed by the assessee for computing income chargeable under the head ‘Profits and gains of business or profession’. The liability is reflected even where there is no actual expenditure; likewise the income is reflected even where there is no actual receipt of money. Accrued income is revenue received but not actually reported in the account books. In this case, too, an adjustment entry will be required, similar to the accrued expenses. Some examples of accruals may include receivables, accounts payable, accrued rent, and so on. The interest expense generally accrues over a period of time and it is irrespective of company’s operational productivity during a given period of time.

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These are better known as current liabilities, as the payments are settled within twelve months. These expenses are reflected in the organisation’s balance sheet as pending payments that have not yet been billed. If the payments are made after the year expires, such expenditures are no longer considered current liabilities but long-term liabilities. You accumulate a liability in one FY and pay the expenditure incurred in another FY.

If the payee is identifiable and the amount payable to him is ascertainable, then the assessee would be required to deduct tax at source in respect of such provision. However, in case payee is not identifiable, the provision of Chapter XVII-B related to deduction at source, cannot be pressed into service and, therefore, the assessee is not required to deduct tax at source in such a case. However, accrual of expense and revenue provision vs accrual is recognised by accounting standards both Indian and international accounting standards. Accruals include accounts receivable, annual income tax dues, accounts payable, rent dues, and interest costs. Rules used for example 2 and 3 are of matching costs with revenue and relevancy of time period. Here, costs are matched either against revenues so recognized or against the relevant time period to determine periodic income.

The expense account is debited in such entries, and the accumulated liabilities are credited. All the debit balances directly connected with the accrued income are recorded on the balance sheet. The change in revenues is reflected in the income statement of the organisation. Otherwise, inattention by the accounting staff could depart these changes on the books in perpetuity, which may cause future financial statements to be incorrect. Reversing entries may be set to automatically reverse in a future period, thereby eliminating this threat.

Special Reserves are those created for some specific purpose and can be used only for those specific purposes. Examples of Special Reserves include investment fluctuation reserves, debenture redemption reserves, etc. Normally, a corporation is able to pay the dividend due to the shareholders only from revenue reserves, and they are not allowed to pay the dividend from the capital reserve.

Examples of accrued expenses

In accounting, accrued expenses and provisions are separated by their respective degrees of certainty. By contrast, provisions are allocated toward probable, but not certain, future obligations. Interest expense is the cost incurred by an entity in connection with the borrowing of funds which may include loans, bonds or other forms of credit for business purpose or for the acquisition of asset. It is a non-operating expense shown on the income statement representing interest accrued during the period covered by the financial statements and not by the amount of interest paid during the period. It also recognizes the assets, liabilities, revenue and accrued expenses for the amounts received or paid in cash in the past, and amounts expected to be paid or received in cash in the future.

In these facts, the Hon’ble Karnataka High Court has held that tax was not required to be deducted as no income was accrued to the recipient. In this case, the assessee was booking those expenses in the profit and loss account for which invoices had been submitted or the payments had become due. Such expenses were accounted for and if TDS was found to be applicable on these expenses, the same was accounted for. Instead, applicability of TDS on provision for expenses was solely made on the basis of the explanation embodied in section 194C. As per the said Explanation, TDS liability would arise even if the amount is credited to any account – whether called suspense account or called by any other name. The scheme of Chapter XVII-B of the Income-tax Act, 1961 was not taken into account while decking the issue.

Contingent losses should be provided by a charge in the profit and loss statement only if it is confirmed that an asset has been declared not of use, impaired etc. and a rationale estimate of the resulting loss can be made. Whichever method is used for accounting, needs to be well-thought of, as it cannot be changed again and again, and the change also requires an elaborate process. Once you’ve decided on an accounting method, you’re expected to use it regularly. If your goal is to reduce or avoid taxes, you cannot frequently change your accounting technique. Cash accounting might only postpone tax payment and not actually reduce it.

By clicking on ‘ENTER’, the visitor acknowledges that the information provided in the website does not amount to advertising or solicitation and is meant only for his/her understanding about our activities and who we are. Typically, such provisions are made on the last date of the every month, quarter or half yearly or annually, as the case may be, and usually reversed on the first day of the subsequent month /quarter / half year or year respectively. Usually, such provisions are made on estimated basis or on historical data base available in some cases. Next year, on the 1st day of the new financial year, the provisional entries need to be reversed. The proviso to sub-section provides that where by virtue of any provision of this Act income-tax is to be charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly. The Id AO also failed to consider the legal position emanating from the decided case laws cited before him and went wrong in relying on the decision not relevant to the facts of the appellant’s case.

What is ‘Accrual Accounting’

A provision, on the other hand, are quite uncertain for any business but are not totally uncertain hence the provision is made by businesses to hedge any future potential losses in the business. Accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees. The business is usually considered to be a “going concern which means that it is in operating for the foreseeable future. It is presumed that the business does not have the intention or the need to shut down or reducing the size of its operations. Therefore, use of ‘going concern’ assumption in preparation of financial statements reflects that such entity has intention to continue business activities/ operation in foreseeable future. In other words there is no plan to discontinue/ liquidate the business in near future.

• An entity may earn interest income from various avenues and thus its presentation in the financial statements will largely depend on the nature of business’ primary operations.
• The amount of provision cannot be accurately determined at the date of the balance sheet, though the liability is known.
• Pfizer’ case- The provision for expenses was made without crediting the same to the accounts of the respective payees.
• A business might have earned fees from having supplied providers to shoppers, however the accounting records don’t yet contain the revenues or the receivables.
• General reserves are those which are generally created without any specific purpose.

Provisions or for any unascertained liability and these provisions of year-end expenses are ascertained liabilities which are paid at the actual rate in subsequent years and are not subject to disallowance under section 37. Tax deducted at source is considered to be tax paid on behalf of the person from whose income the deduction was made and, therefore, the credit for the same is to be given to such a person. A capital reserve is usually created out of a profit which is capital in nature such as capital gains, premium on issue of shares or debentures, profit prior to incorporation, profit on revaluation of asset or liabilities, etc. It should not be used to distribute a dividend among the shareholders. Instead, it is used to strengthen the financial position of the business, or to write off the capital loss or losses of abnormal nature. Provision is an amount that is put away from the profit earned by the company to cover expected losses or expenses even though the specific amount might be unknown.

As per the scheme of Chapter XVII-B of the Income-tax Act, 1961, there is a provision for deduction of tax at source. Ordinarily, the deduction is to be made at the time of payment or the credit of the amount to the account of payee. However, as per provision of section 194C, the tax is to be deducted even if the amount is not credited to the account of the payee but to a suspense account.

These accumulated expenses are liabilities at the end of that specific accounting timeframe. You need to reverse these liabilities when the payments are made in the next accounting year. Thus, what was recorded earlier as debts will now reflect expenditures incurred.

Expenses incurred in a specific accounting timeframe are considered accrued expenses, but the payment for which will be made in another accounting timeframe. Every commercial business functions on the facility of loans and deferred payments. Accrued expenses are one such type of expenditure that businesses resort to.

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Reserves are not created by debiting to Profit & Loss Account but through Profit & Loss Appropriation A/c. How do you then decide on which life insurance plan works for you and how should you go about buying the one best suited for you. A good financial plan in place can help you achieve these goals at the required time. Parents have huge aspirations for their child / children and are always willing to go that extra mile to secure their future financially.