Definition and Explanation
Accrued liabilities result from non-transaction economic events. Their recognition is generally triggered by the occurrence of a financial statement date rather than transactions. Typically, accrued liabilities are very short term in nature; indeed, many of them are paid by the time the statements are released. Unless there is some special significance concerning the nature of the accrual, all accrued liabilities are summarized as a single item on the balance sheet.
Payments to employees for holidays, vacations, and sick leave are better matched with the periods in which they actually work rather than those in which absence occurs. The implementation of the approach requires accrual of liability for the difference between the payroll expense (including compensated absences) and the amount actually paid. Then, when a compensated absence occurs, payment to the employee represents a settlement of the accrued liability rather than an additional expense.
Example of Accrued Liabilities
Consider this simple example for a single employee for a year. The terms of employment allow 20 days of paid vacation per year and salary of $26,100. After allowing for 104 weekend days, there are 261 (365 less 104) compensated days even though the employee works only 241 days out of the year. Thus, the compensation is $100 per compensation day ($26,100 divided by 261 days), but the employer’s expense is $108.30 per working day ($26,100 divided by 241 days). The $8.30 difference is accrued every working day as a vacation liability. When vacation days are taken, the liability is debited instead of Payroll Expense.
This journal entry would be made for a 10-day pay period (ignoring payroll taxes and withholdings) in which no vacation is taken:
The expense is computed for 10 days at $108.30 per day.
For a pay period in which the employee works four days and takes six days of vacation, this journal entry
The payroll expense is computed as 4 days at $108.30; the debit to the vacation liability is computed as 6 days at $100; the cash payment is 10 days at $100; finally, the credit to vacation liability is computed as 4 working days at $8.30.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.