What Are Accrued Expenses?

What Are Accrued Expenses?

Let me explain accrued expenses to you directly: they're costs you've recognized in your books before actually paying them. You record these in the period they occur, following accrual accounting, which is the go-to method under GAAP.

Key Takeaways

You need to know that accrued expenses hit the books when incurred, not paid. Accrual accounting demands more journal entries than cash basis, but it gives you a truer financial view. Public companies trading on exchanges must use accrual methods. Remember, accruals cover events that happened without cash changing hands yet, unlike prepayments where cash goes out before the event.

Understanding Accrued Expenses

As a business owner or accountant, you list accrued expenses as current liabilities on your balance sheet because they represent future payments you owe. Sometimes it's an estimate, not matching the eventual invoice. You recognize them when incurred, not paid. For instance, if you buy supplies without an invoice yet, that's accrued. Same goes for loan interest, warranties, taxes, or employee wages earned but not paid—record them in the period they happen.

When you accrue expenses, your unpaid bills pile up, boosting both expenses and liabilities on your statements.

Accrual vs. Cash Basis Accounting

You should understand how accrual differs from cash basis: cash basis only records when money moves, which can skew income and balances. Accrual, though more work with all those entries, paints a fuller picture of your company's health and future. It helps you grasp transactions accurately each period.

Accrued Expenses vs. Prepaid Expenses

Accrued expenses are the flip side of prepaid ones. Prepaids are advance payments for future goods or services, shown as assets since you'll get value later. Accruals, however, are obligations you've incurred but not paid, like an expected lawsuit loss—you record the expense and liability now, even without payment. It's the opposite: accrual recognizes past events with pending cash, while prepayment handles future events with cash already settled.

Advantages and Disadvantages of Accrued Expenses

On the plus side, accrued expenses make your financials more precise by including pending activities. Say you contract for consulting; you recognize the $5,000 obligation right away. This consistency aids planning and meets SEC requirements for some firms.

Drawbacks include the extra time for preparation and higher misstatement risks without auto-reversals. You might accidentally double-count if you've already paid. Plus, it muddles actual cash flow since non-cash items flood the ledger, ignoring bank impacts.

Special Considerations

Reversing entries are key—you back out the accrual next period to avoid duplicates. These are temporary placeholders until the real transaction hits. Many software tools handle this automatically.

At month-end or year-end, you book as many invoices as possible, then accrue the rest. This is big for external reporting, usually done during close, not mid-month.

Example of Accrued Expenses

Picture this: your company pays salaries on the first of next month for prior work. For December 31, if you only record paid salaries, you miss December's expense. So, you make an adjusting entry: debit salary expense, credit salaries payable. When paid, credit accounts payable, then debit it and credit cash once settled.

How Are Accrued Expenses Accounted For?

You account for them as liabilities recognized before payment, in the incurred period, shown as current liabilities.

What Are Some Examples of Accrued Expenses?

Examples include supplies bought without invoice, loan interest, warranties, taxes incurred but unpaid, and employee commissions earned in one period but paid next.

How Does Accrual Accounting Differ From Cash Basis Accounting?

Accrual recognizes events regardless of cash timing, for accuracy; cash basis waits for payment, often distorting figures.

What Is a Prepaid Expense?

It's an asset from advance payments for future value, expensed over time.

What Is the Journal Entry for Accrued Expenses?

Debit the expense, credit accrued liability; reverse next period. For a $10,000 utility in June, debit expense, credit payables; in July, debit payables, credit cash.

The Bottom Line

If you're using accrual accounting, you recognize expenses when incurred, not paid, for consistent statements—though it requires more effort than cash methods.