Why does an increase in Accrued Expense affect Income Statement but not a decrease?
For a $10 increase in Accrued Expense with 40% tax rate:
IS: Pre-tax income down $10, Net income down $6
CFS: Net income down $6, add back $10 in CFO, net change in cash is up $4
BS: Cash up by $4, Liabilities up by $10, SE down by $6, both sides balance
But for a $10 DECREASE in Accrued Expense with 40% tax rate this website said this:
IS: No changes to the income statement
CFS: Accrued Expenses decrease by $10 which is a cash outflow under Cash flow from operations and your change in cash is a decrease of $10
BS: Cash is down by $10 on the assets side and on the liabilities side Accrued expenses are down $10 to make everything balance
For a decrease, I thought net income would go up by $6. On CFS, you subtract $10, so net change in cash is -$4.
BS: Cash down by $4, Liabilities down by $10, and SE up by $6 and both sides balance.
A decrease in accrued expense means you are recognizing less expenses on the income statement, so how could it not affect the income statement? Especially if you recognize an increase.
The expense has been recognized and if there’s a decrease it’s just related to cash changed between hands it’s not a second recognition on the Income Statement
i don't understand
--
Accrual basis accounting does not care about when cash was received or paid. What it cares about is when the activity took place.
Let's use utilities for example. You accrue for utilities expense all throughout the month in which you use those utilities. You may not pay them for 3 months (whatever the reason may be) but you will still show an expense on the IS because that's when you received those utilities and when the activity occurred.
So what happens when you eventually pay cash? You've already expensed it on the Income Statement. There is no need to show it again. Instead you lower cash by $10 and lower accrued expenses by $10.
I would encourage you to read and learn about accrual basis accounting and the difference with cash basis.
Think of someone mowing your lawn
They mow your lawn for the farm you own, but you don’t have the cash to pay them
But the lawnmower has known you for years and trusts you
So help let’s you pay within the next 60 days because he values your business
When they guy mowed your lawn, you acrrued the expense (when the work was done). You know have a mowed lawn that should have cost you cash, but didn’t. You recognize that the expense happened in that time period, but you didn’t pay cash for it. So it flows through your income statement because that’s when the cost of operating your business occurred.
Now you have an IOU to the lawnmower, your accrued expense. You have 60 days to pay him, and pay him on day 25. Your IOU goes down because you gave your lawnmower the cash. So your accrued liability, your IOU, goes down while cash goes down, the cash you gave your lawn mower. They didn’t “unmow” your lawn nor did they mow it again, nothing to do with the income statement.
Technically an accrued expense is just a current liability. When current liabilities go up, it’s a source of cash, and when current liabilities go down, it’s a use of cash. It will be reconciled in the CFO adjustments for changes in working capital, as opposed to somehow shown on the IS again
Okay, so paying down a liability has no effect on the income statement?
No not directly. You have already accounted for that expense in a different time period.
This is correct but I had an aneurysm reading it
I’ll be completely transparent, and I’m sure you can see by a few of my typos, that I may have had a few whiskeys prior to writing this
This would be a good interview question ngl, I can see how it can trip up ppl who don't fully understand accrual accounting
Dolore dolor voluptate itaque eligendi repellat. Molestiae exercitationem eos illo et nostrum iusto quaerat.
Fuga non blanditiis fuga voluptates voluptatem eos eos. Rerum ea quaerat dicta iusto incidunt. Sit voluptatem distinctio cupiditate quis est doloribus. Ipsa distinctio molestiae et consectetur consectetur. Beatae a asperiores atque at aut temporibus. Magni ut dolorem dolor non assumenda eum.
Occaecati placeat nulla quae eius. Debitis necessitatibus est reiciendis non sit aperiam inventore. Hic et voluptates at aut.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...