Accrued Wages (Definition, Measurement, Classification, and Journal Entry)

Definition

Accrued wages refer to the total amount of liability that remains in the books of accounts at the end of an accounting period. These are the workers’ wages, but the business has not paid them as of period closing (although workers have performed their work). Recording of the accrued wages helps the business to complete its accounting record in terms of expense recording.

Detailed understanding

It is important to note that if the business has obtained a certain economic benefit with the work of labor in a specific period, there is a need to recognize an expense in the same period irrespective of whether payment has been made. This recording of expenses helps to comply with the matching principle of accounting.

On the other hand, if the company follows a cash basis of accounting, wages and other expenses are only recorded when paid. Hence, accrued wages are the only valid term when the business uses the accrual basis of accounting.

It’s equally important to note that there is some difference between recording accrual and accounts payable. The business must have bills/invoices from suppliers and terms for the payment decided to record accounts payable. On the other hand, to record an accrual, the business must have consumed services irrespective of the fact that an invoice/bill from the supplier is received or not.

Further, accrual expenses can also be recorded based on estimates or trends. However, the correction must be made once the bill is received to ensure the accounting record aligns with the accurate charges.

US GAAP and International Financial Reporting Standard – IFRS requires companies to ensure compliance with an accrual basis of accounting. Under these accounting systems, the transactions are recorded instantly as they occur, irrespective of whether all aspects of the transaction are complete or not.

When an entry is posted in the accounting system under the accrual basis of accounting, it gives rise to two elements of transactions. So, when it’s applied for making cash payment in advance or keeping an amount due, this gives rise to prepaid and accrued accounts, respectively. To record prepaid, the business must have paid cash and intends to utilize economic benefit in the coming accounting period.

Similarly, an account that gives rise to liability is known as the accrual for that business entity. To record accrual, the business must not have paid wages but consumed the services of the workers.

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Accrual in terms of wages

Wages of hourly workers are the compensation or remuneration of work or services provided to a business. The wages represent the remuneration before the tax and allowance deductions and include the perquisites value and fringe benefits provided to the accrued wages. On the other hand, Accrued wages are defined as the amount of liability for wages that have been earned by hourly workers but not yet paid to them at the end of an accounting period. Accrued wages are recorded to determine the entire expense incurred during a reporting period instead of the amount paid.

Measurement of accrued wages:

Measurement of the accrued wages is dependent on the total hours worked by the workers of the company. If the company pays workers immediately or on the same day of work, it’s recorded as a normal expense.

However, sometimes, there is a gap between paying for the work and consuming the services of the workers. So, suppose an accounting period closes between this lag time of consuming services and paying for the work. In that case, the business needs to reflect this fact in the accounts by creating liability under the head of accrued wages.

Determination of balance for accrued wages is also important for the business as per the internal control perspective. It helps them to assess the amount payable to the workers. Further, this information is essential for the business to ensure completeness of the liability in the financial statement, which is one of the basic assertions.

Here is the way, how accrued wages can be measured by following the simple steps:

  1. Calculate the total hours that the workers have worked and have not yet been paid. The number of hours can be obtained from the timesheet maintained by the payroll/HR department of the business.
  2. Multiply the total number of hours with the hourly wage rate. The rate per hour can be obtained from a contract with the employees.
  3. Add the all payable wages of every worker to calculate the total accrued wages for the reporting period. However, there is a need to ensure payable balance for all the workers is recorded.
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Let’s take an example to understand the steps necessary to understand the measurement of the accrued wages:

Mr. Chris Jordan is paid $30 per hour. Chris Jordan is paid through the 26th day of the preceding month and has worked 24 hours between the 26th-30th days. The accounting period ends on is 30th.

No of hours worked        = 24

Per hour rate                    = $30

Accrued Wage   = no. of hours worked x per hour rate

                                             = 24 x $30

                                             = $720

The unpaid amount of wage is $720 that employer should record as accrued wage as of the end of the reporting period.

Similarly, the same process will be followed for every worker, and in the end, all the payable wages will be added collectively to calculate the overall accrued wages of a company at the end of the reporting period. This balance will be reported as accrued wages in the balance sheet of the company.

It is important to note that companies tend to accrue wages daily; that’s why an accurate wage accrual figure is a target. The date on which the accrued wages are calculated is important. To accomplish the financial statement, it must be recorded properly and accurately.

If there is some error in the calculations/presentation of the accrued wages, it might lead to misstatement in the financial statement.

Classification:

Wages expense is charged in the income statement. It is recorded as the operating expenses, cost of services or cost of goods sold depending on how the workers are involved in the operations. For instance, if the worker has worked in the production line, the related expenses should be recorded in the cost of sales. So, the nature of the work performed needs to be assessed while mapping the accrued wages in the financial statement.

Accrued wages are the balance sheet account and are usually payable within the next 12 months. And are considered a current liability. In case of any agreement, the payment can be due later than 12 months; in such case, the accrued wage are classified in the balance sheet as a non-current liability.

Accrued wages journal entry:

If workers work during an accounting period and the company does not pay them for their work, the wages earned by the workers will be treated as the current liability for the company.

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The company will record an adjusting entry to record the unpaid wages of workers. Let’s take the above example of Chris Jordan to show the entry:

DateDescriptionDrCr
 Wages expense A/C$720 
 Accrued Wages A/C $720
(Wages outstanding at the end of the reporting period)

When the company pays wages, the journal entry for wages paid for cash is recorded as shown below:

DateDescriptionDrCr
 Accrued wages A/C$720 
 Cash A/C             $720
(Paid wages to workers to eliminate liability from accounting books)

                                      

Bottom line

Accrued wages is an account that records all the unpaid wages to show the amount earned by the workers but not yet paid to them by the company. From the employers’ and workers’ points of view, understanding the complexities of accrued income is more important.

This article has explained the basics of accrued wages and how to measure, record, and classify them in its book of accounting records.

Frequently asked questions

Why are accrued wages presented in the liability section of the balance sheet?

Accrued wages are the amount payable for which the business has consumed value in the accounting period. Further, settlement of the accrued wages requires the outflow of the economic benefits from the business. Hence, the accrued wages are classified as a liability in the balance sheet.

Accrued wages is debit or credit item?

Accrued wages are credit items in the balance sheet. Being liability, the balance of the accrued wages is presented on the credit side of the balance sheet.

What’s the difference between accrued wages and accrued liability?

The accrued liability is a broader term and includes all the balances related to accrued expenses. For instance, accrued utility bills, accrued wages, and all other balances the business has consumed value, but bill/invoice is not received is classified in the accrued liability.

What is deferred income, and how it’s classified in the balance sheet?

Deferred revenue is an advance that the business has received from the customers. Since the business has received the cash but has not performed services yet, so, that’s the liability of the business and classified as the same in the balance sheet.

How is prepaid balance linked to accrued wages?

Prepaid balance is an amount the business has paid in advance to avail of some services. It’s the opposite of the accrued balance and classified as a current asset in the balance sheet.

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