Question

A company uses the accrual basis of accounting. The company has $7,800 of accrued salaries for this period, that won’t be paid until the next period. It was decided not to record the adjusting entry in this period; After all, sooner or later the expense will be reported. How does this decision impact the financial reporting? Does it really matter if they record it in another period? Please answer both questions and be specific and detailed in your response. Give examples.​

Answer 1

The accrual basis of accounting recognizes expenses in the period in which they are incurred irrespective of the period in which they are paid. Adjusting entries are recorded at the period end to record all such expenses that have accrued during the period but remain unpaid by debiting the respective expense accounts and crediting liability account. Thus, the expense is reported in the correct period on the income statement. At the time of payment, the liability is debited and cash is credited without impacting the income statement of the period in which paid.

In view of the above, the decision to not record the adjusting entry for accrued salaries of $7,800 in this period will impact the financial reporting. The salary expense for this period will be under stated by $7,800 thereby resulting in over statement of the net income for this period by the same amount and also an under statement of liabilities.

When the accrued salaries of $7,800 are recorded when paid in the next period, the salary expense will be debited and cash credited. The financial statements of the next period will also thus be distorted as the salary expense will be over stated and net income under stated to the extent of $7,800.

Hence, the period in which the accrued salaries are recorded does matter in ensuring that the net income for a period and the financial position reported are correct and not misleading.