The most common question we come across in our accounting help online is that for journal entries. This article covers what you need to do for a paid trade expenses journal entry as part of our accounting tutorial series. We’ll look at the types of trade expenses and a few different journal entries for cash and accrual accounting systems.
If you need a quick answer, the debit must be against the trade expense account with a credit to the bank account. However, if you had previously recorded the expense as a creditor, the debit should be applied to this instead. So the journal entry would look something like this:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| March 31 | Trade Expense | 1,000 | |
| Bank | 1,000 |
For more details, please read on.
What is a Trade Expense?
In its simplest form, it is an expense a business incurs as part of its normal operations. Sometimes the term is more associated with direct expenses in the selling of goods and services to customers. For example, for a builder, a direct trade expense would be the purchasing of timber supplies. In contrast, an indirect expense would be the wage costs for admin support.
However, the common usage of the term is any cost incurred in carrying out business activities.
Cash v Accrual Accounting
This distinction, covered in another of our articles in our accounting tutorial series, and you can find that here. A quick summary of it is cash accounting only recognises transactions when cash moves. While accrual accounting measures movement in economic benefits, which is a fancy accounting way of saying that in addition to cash, accrual systems track non-cash movements too – for example, depreciation.
In our case, the distinction is important because it affects the journal entries we will use below. Under a cash system, the trade expense journal entry is made when the expense is paid. While under an accrual system, the trade expense is recognised when it becomes an economic obligation. Another fancy accounting way of saying when we will have to do or pay someone for something is to commit to doing so (the decision, timing and amount are known).
Paid Trade Expenses Journal Entry Example
As we mentioned above, we will look at the journal entry when a trading expense is paid on a cash and accrual basis.
Cash Basis
A cash basis accounting system will, unsurprisingly, only bring to account those transactions involving cash. Things like depreciation of fixed assets, amortisation of finance costs, balance day adjustments, etc., are not recorded as they all involve non-cash transactions.
So life on a cash basis is much easier. This is the option many taxpayers in the UK, including yours truly for our rental property, choose as it keeps the accounting simple.
So for a paid trade expense, we will only record the journal entry when the actual payment is made. Let us assume ABC Ltd has to hire some machinery, which costs them $1,000 for the week. When the payment leaves ABC’s bank account, their accounting system will record the following:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| March 1 | Trade Expense – Machinery Hire | 1,000 | |
| Bank | 1,000 |
Accrual Basis
Under an accrual accounting system, we do have the added complication of non-cash items and, in this case dealing with creditor accounts. Often in business, expenses are incurred, but no cash changes hands; the purchaser has bought the good or service on credit (why we don’t use the word debt these days is beyond me).
Carrying on the ABC example, but this time ABC pays for the hire on account, i.e. on credit, with the hire firm, and so their accounting system would record the following journal entry:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| March 1 | Trade Expense – Machinery Hire | 1,000 | |
| Creditors | 1,000 |
The same debit is made to the machine hire expense account for $1,000, thus increasing this expense account. But this time, the credit part of the entry is posted to creditors as ABC now has a liability (i.e. an economic obligation to pay a third party, in the future, a specific amount, at a particular time). As per International Financial Reporting Standards (IFRS) Conceptual Framework. You don’t have to worry about conceptual frameworks here, but just know this is where we get our definitions of things like expenses and liabilities.
ABC must settle the account by month-end, and so on March 25, it sends the hire firm payment of $1,000:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| March 25 | Creditors | 1,000 | |
| Bank | 1,000 |
With creditors naturally being a credit account, a debit of $1,000 reduces that balance. At the same time, the credit of $1,000 to the asset account Bank reduces a natural debit balance account.
Conclusion
That is about it in what journal entry to make for paid trade expenses. The only issue is whether a cash or accrual accounting system is being used and whether the expense, when incurred, was paid for in cash or put on credit.
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