Accrued Expense
What Is an Accrued Expense?
An accrued expense, also known as accrued liabilities, is an accounting term that
refers to an expense that is recognized on the books before it has been paid. The
expense is recorded in the accounting period in which it is incurred.
KEY TAKEAWAYS
Accrued expenses are recognized on the books when they are incurred,
not when they are paid.
Accrual accounting requires more journal entries than simple cash balance
accounting.
Accrual accounting provides a more accurate financial picture than cash
basis accounting.
Understanding Accrued Expenses
Since accrued expenses represent a company's obligation to make future cash
payments, they are shown on a company's balance sheet as current liabilities. An
accrued expense can be an estimate and differ from the supplier’s invoice that
will arrive at a later date. Following the accrual method of accounting, expenses
are recognized when they are incurred, not necessarily when they are paid.
An example of an accrued expense is when a company purchases supplies from
a vendor but has not yet received an invoice for the purchase. Other forms of
accrued expenses include interest payments on loans, warranties on products or
services received, and taxes—all of which have been incurred or obtained, but
for which no invoices have been received nor payments made. Employee
commissions, wages, and bonuses are accrued in the period they occur although
the actual payment is made in the following period.
When a company accrues (accumulates) expenses, its portion of unpaid bills
also accumulates.
Accrual vs. Cash Basis Accounting
Accrual accounting differs from cash basis accounting, which records financial
events and transactions only when cash is exchanged—often resulting in the
overstatement and understatement of income and account balances.
Although the accrual method of accounting is labor-intensive because it requires
extensive journaling, it is a more accurate measure of a company's transactions
and events for each period. This more complete picture helps users of financial
statements to better understand a company's present financial health and predict
its future financial position.
Accrued Expenses vs. Prepaid Expenses
Accrued expenses are the opposite of prepaid expenses. Prepaid expenses are
payments made in advance for goods and services that are expected to be
provided or used in the future. While accrued expenses represent liabilities,
prepaid expenses are recognized as assets on the balance sheet.
Example of Accrued Expense
A company pays its employees' salaries on the first day of the following month for
services received in the prior month. So, employees that worked all of November
will be paid in December. If on Dec. 31, the company’s income statement
recognizes only the salary payments that have been made, the accrued
expenses from the employees’ services for December will be omitted.
Because the company actually incurred 12 months’ worth of salary expenses, an
adjusting journal entry is recorded at the end of the accounting period for the last
month’s expense. The adjusting entry will be dated Dec. 31 and will have a debit
to the salary expenses account on the income statement and a credit to the
salaries payable account on the balance sheet.
When the company’s accounting department receives the bill for the total amount
of salaries due, the accounts payable account is credited. Accounts payable is
found in the current liabilities section of the balance sheet and represents the
short-term liabilities of a company. After the debt has been paid off, the accounts
payable account is debited and the cash account is credited.
How Are Accrued Expenses Accounted for?
An accrued expense, also known as an accrued liability, is an accounting term
that refers to an expense that is recognized on the books before it has been paid.
The expense is recorded in the accounting period in which it is incurred. Since
accrued expenses represent a company's obligation to make future cash
payments, they are shown on a company's balance sheet as current liabilities.
What Are Some Examples of Accrued Expenses?
An example of an accrued expense is when a company purchases supplies from
a vendor but has not yet received an invoice for the purchase. Other forms of
accrued expenses include interest payments on loans, warranties on products or
services received, and taxes—all of which have been incurred or obtained, but
for which no invoices have been received nor payments made. Employee
commissions, wages, and bonuses are accrued in the period they occur although
the actual payment is made in the following period.
How Does Accrual Accounting Differ From Cash Basis Accounting?
Accrual accounting measures a company's performance and position by
recognizing economic events regardless of when cash transactions occur,
whereas cash accounting only records transactions when payment occurs.
Accrual accounting presents a more accurate measure of a company's
transactions and events for each period. Cash basis accounting often results in
the overstatement and understatement of income and account balances.
What Is a Prepaid Expense?
A prepaid expense is a type of asset on the balance sheet that results from a
business making advanced payments for goods or services to be received in the
future. Prepaid expenses are initially recorded as assets, but their value is
expensed over time onto the income statement. Unlike conventional expenses,
the business will receive something of value from the prepaid expense over the
course of several accounting periods.