When Accrued Compensation increases by $10, which statement best describes its impact on the income statement?

• A. OpEx increases $10, Pre-tax income decreases $10, Net income decreases $8 (assuming 20% tax rate)
• B. OpEx increases $10; Net income decreases $10
• C. OpEx decreases $10; Pre-tax income increases $10
• D. No change to OpEx

Answer: (A)

Accrued compensation is recognized as an operating expense in the period it’s earned, even if cash isn’t paid yet. So an increase of ten for accrued compensation raises operating expenses by ten, which lowers pre-tax income by ten. Taxes are based on pre-tax income, so a 20% tax rate reduces the tax expense by two, leaving net income down by eight. In other words, the income statement shows OpEx up by ten, pre-tax income down by ten, and net income down by eight at a 20% tax rate. The other statements either ignore the tax impact or reverse the effect on OpEx, which is why this option best describes the change.