The most common questions we come across in our Accounting help online is that for journal entries. In this short article as part of our accounting tutorial series is what is the Journal Entry for paid trade expenses. We’ll look at what these expenses are and a few different journal entries for both cash and accrual accounting systems.

If you need the quick answer the debit needs to be against the trade expense account with a credit to bank. However, if you had previously recorded the expense as a creditor, the debit should be applied to his instead.

For more details … please read on.

What is a Trade Expense?

In its simplest form it is any 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. Where as 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 has been covered in another one of our articles in our accounting tutorial series and you can find that here. The 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 only 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 and we are committed to doing so (the decision, timing and amount are known).

Paid Trade Expenses Example Journal Entry

As we mentioned above we will look at the journal entry when a trade expense is paid under both a cash basis and an 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 under a cash basis is much easier. In the UK this is the option chosen by many tax payers, yours truly included for our rental property, as it keeps the accounting simple.

So for a paid trade expense we are only going to record the journal entry when the actual payment is made. Let us assume ABC Ltd has to hirer some machinery and this costs them $1,000 for the week. When the payment leaves ABC’s bank account their accounting system would record the following:

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”, ie on credit, with the hire firm and so their accounting system would record the following journal entry:

The same debit is made to machine hire 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 (ie an economic obligation to pay a third party, in the future, a specific amount, at a specific time).

ABC must settle the account by month end, and so on March 25 it sends the hire firm payment of $1,000:

With creditors naturally being a credit account, a debit of $1,000 reduces that balance. While 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.

We always welcome your feedback on our work. Or if you have any questions or would like other material covered please let us know.

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