Accrued Compensation up by $10: What happens to Operating Expenses and Net Income?

Accrued Compensation up by $10: What happens to Operating Expenses and Net Income?

• A. Operating Expenses up by $10; Net Income down by $6
• B. Operating Expenses down by $10; Net Income up by $6
• C. Operating Expenses up by $6; Net Income down by $4
• D. No change in Income Statement

Answer: (A)

Accruing compensation records an expense now even though no cash has left the company yet. That pushes operating expenses up by the full amount, here $10. The expense reduces pretax income by $10, and after taxes the impact on net income is smaller. With a 40% tax rate, the after‑tax effect is $10 × (1 − 0.40) = $6, so net income falls by $6. There’s no cash change in this moment—the cash outlay will occur later when the compensation is paid. The balance sheet would reflect an increase in accrued compensation payable (a current liability) by $10, and cash remains unchanged until payment.

Accruing compensation records an expense now even though no cash has left the company yet. That pushes operating expenses up by the full amount, here $10. The expense reduces pretax income by $10, and after taxes the impact on net income is smaller. With a 40% tax rate, the after‑tax effect is $10 × (1 − 0.40) = $6, so net income falls by $6. There’s no cash change in this moment—the cash outlay will occur later when the compensation is paid. The balance sheet would reflect an increase in accrued compensation payable (a current liability) by $10, and cash remains unchanged until payment.