Accrued expenses are goods and services a company has received but hasn’t paid for yet. Even though no cash has exchanged hands, a company will account for accrued expenses in the budget.
This type of accounting, called the accrual method, allows a company’s financial statements (such as the balance sheet and income statement) to be more accurate. However, it requires more journal entries than simple cash basis accounting.
Read on for an in-depth look at accrued expenses, including what they are, examples of accrued expenses, plus how accrual accounting compares to other accounting methods.
Key Points
• Accrued expenses are recorded when incurred, not when paid, and appear as current liabilities on the balance sheet.
• Examples of accrued expenditures include employee wages, utility bills, and interest on loans.
• Accrual accounting is more complicated than cash basis accounting but provides a more accurate financial picture.
• Prepaid expenses differ from accrued expenses as they are paid before receiving goods or services.
• Accrued expenses can impact cash flow and financial statements, influencing business loan approvals.
What Are Accrued Expenses?
By definition, accrued expenses are expenses a company accounts for when they happen, as opposed to when they are actually invoiced or paid for.
An example of an accrued expense is when a company purchases supplies from a vendor and has not yet received an invoice or paid for the purchase. Other examples include employee wages, commissions, and bonuses, also known as accrued compensation. These costs accrue in the period they occur even though the actual payment is made in the following period. Interest on a small business loan or taxes can also be considered accrued expenses.
Tracking accrued expenses is important because they represent a liability (money that must eventually be paid out) for your company and can significantly impact your cash flow and key financial statements.
Key Characteristics
Key characteristics of accrued expenses in a small business include:
• Incurred but unpaid: These expenses have been incurred during a period but not yet paid.
• No invoice received: Often recorded without a formal bill, based on estimates.
• Recorded in the period incurred: Ensures accurate matching of expenses to revenue in financial statements.
• Short-term liability: Typically settled within a short time, like payroll or interest.
• Affects cash flow and profitability: Impacts both budgeting and financial planning.
Recommended: Guide to Single-Step and Multi-Step Income Statements
How Accrued Expenses Work
With an accrued expense, there is no documentation of the expenditure — at least not yet. In place of that documentation, a bookkeeper or owner will create a journal entry to record an accrued expense, as well as an offsetting liability. If no journal entry was made, the expense would not appear in any of the company’s financial statements for that period. This could result in reported profits being too high in that period.
Reporting accrued expenses helps increase the accuracy of financial statements, so that expenses are more closely aligned with the revenues they are associated with. In some cases, accrued expenses will be an estimated amount of what’s owed. This is then adjusted later to the exact amount once the invoice has been received.
Since accrued expenses represent a company’s obligation to make future cash payments, they are recorded on a business’s balance sheet as current liabilities.
Accounting Mechanism
The accounting mechanism behind accrued expenses follows the accrual basis of accounting, ensuring expenses are recognized when incurred, not when paid. Here’s how it works:
1. Expense recognition: When a business incurs an expense (wages earned by employees or utilities used) but hasn’t yet paid for it, the accountant records it in the same accounting period.
2. Journal entry: A journal entry is made to:
a. Debit the appropriate expense account (salaries expense, interest expense).
b. Credit an accrued liability account (accrued expenses payable).
3. Balance sheet impact: This creates a liability on the balance sheet, showing the company owes money.
4. Payment and adjustment: When the company eventually pays the expense, the liability account is debited (reduced), and “cash” or “bank” is credited.
This mechanism ensures accurate financial reporting, even when cash has not yet changed hands.
Recognition Principle
The recognition principle states that expenses should be recognized in the same period as the revenues they help generate, regardless of when the cash is actually paid. Here’s how it works:
• Timing: An accrued expense is recorded when the obligation is incurred — not when the payment is made.
• Purpose: This aligns expenses with the period in which they contribute to revenue, offering a more accurate picture of financial performance.
• Example: If a company uses electricity in December but doesn’t receive the bill until January, the expense is still recognized in December.
In short, the recognition principle ensures that a business’s income statement reflects all expenses tied to the period’s activities, giving stakeholders a clearer view of profitability.
Recommended: 9 Accounting Basics Every Small Business Owner Should Know
Accrual vs Cash Basis Accounting
When managing a business’s finances, one of the most important decisions is choosing between accrual basis accounting and cash basis accounting. These two methods determine how and when income and expenses are recorded, directly affecting financial reporting, tax planning, and strategic decision-making.
While cash basis accounting records transactions when cash changes hands, accrual accounting captures them when they are earned or incurred — regardless of payment timing. Understanding the differences is essential for accurate financial insight and regulatory compliance.
Fundamental Differences
There are some key differences between cash vs. accrual accounting.
As stated above, cash basis accounting records money and expenses when money is actually received or paid. Accrual accounting, by contrast, records revenues and expenses when they are earned, regardless of when the money is actually received or paid. The actual money may be sent or received during a different reporting period.
Accrual basis of accounting is in accordance with the Generally Accepted Accounting Principles (GAAP), whereas cash basis accounting is not.
Here’s a side-by-side comparison of cash basis accounting vs accrual accounting.
| Cash Basis Accounting | Accrual Accounting | |
|---|---|---|
| Revenue is recorded when it is earned | X | ✓ |
| Revenue is recorded when it is received | ✓ | X |
| Expenses are recorded when money is paid | ✓ | X |
| Expenses are recorded before money is paid | X | ✓ |
| Often used by small businesses | ✓ | X |
| Provides a more accurate picture of profitability | X | ✓ |
| Can provide inaccurate view of bank funds | X | ✓ |
| Required of companies following GAAP | X | ✓ |
Accrued Expenses Examples
Some examples of the accrued expenses that your company might need to track include:
• Employee wages
• Services received
• Interest on small business loans
• Taxes
• Utility bills
• Computer equipment
• Office supplies
Let’s take a closer look at office supplies to get a more detailed example of an accrued expense.
Let’s say your company receives office supplies from a supplier on June 25th. The invoice (expected to be $600), however, doesn’t come in before you close the company’s books for June. To record this accrued expense in the month you received it, you would record a debit of $600 to the office supplies expense account and a credit of $600 to the accrued expenses liability account.
When you later receive the supplier invoice for $600, you would record it through the accounts payable module of your small business accounting software. This results in a debit to the office supplies expense account and a credit to the accounts payable account. As a result, there is no new expense recognition the following month.
Recommended: Understanding Budgeted Income Statements
Prepaid vs Accrued Expenses
Prepaid expenses are the opposite of accrued expenses. With accrued expenses, the company has received goods and services but has not yet paid for them. With prepaid expenses, the company pays for goods and services it has not yet received but expects to receive or use in the future.
While accrued expenses represent liabilities, prepaid expenses are recognized as assets on the balance sheet. That’s because the company expects to receive future economic benefit from the prepayment.
Here’s a closer look at prepaid expenses vs. accrued expenses.
| Prepaid Expenses | Accrued Expenses | |
|---|---|---|
| Payment is made before any goods or services have been received | ✓ | X |
| Recorded as a current asset on a balance sheet | ✓ | X |
| Recorded as a current liability on a balance sheet | X | ✓ |
| Payment is made after goods or services are received | X | ✓ |
Recommended: Guide to the Working Capital Cycle
Accrued Expenses on a Balance Sheet
Accrued expenses are recorded on a company’s balance sheet, which shows what a company owns (its assets) and owes (its liabilities) as of a particular date, along with its owners’ equity.
Accrued expenses are recorded under current liabilities, which are a company’s financial obligations that are due within one year or within a normal operating cycle.
Recording Accrued Expenses
With accrued expenses, you typically accrue a liability in one period and pay the expense in the next period. That means you enter the liability in your books at the end of an accounting period. Then in the next period, you reverse the accrued liabilities journal entry when you pay the debt. This shows the expense paid instead of a debt owed.
Keep in mind that you only deal with accrued liabilities if you use accrual accounting. Under the accrual method, you record expenses as you incur them, not when you exchange cash. With cash basis accounting, on the other hand, you only record transactions when cash changes hands.
Impact on Financial Statements
Accrued expenses impact a company’s financial statements by increasing liabilities and reducing net income during the period they are recorded. Here’s how they show up:
• Income statement: Accrued expenses are recorded as an operating expense, lowering net income even though the cash hasn’t been paid yet.
• Balance sheet: They appear under current liabilities, representing obligations the company must settle in the near future.
• Cash flow statement: They do not immediately affect the cash flow until the cash is actually paid.
This approach ensures that the company’s financials reflect a more accurate picture of its financial obligations and performance during the reporting period.
Best Practices for Reporting
In order to ensure best practices for reporting accrued expenses, follow these guidelines:
• Be consistent: Apply the same methods across reporting periods to maintain comparability.
• Be as accurate as possible: Use reliable data and historical trends to estimate expenses when exact amounts aren’t available.
• Record in a timely manner: Record accrued expenses in the correct accounting period to align with the matching principle.
• Be detailed: Maintain detailed records supporting the accrual, including contracts, invoices, or calculation notes.
• Regularly review and adjust as needed: Regularly review accrued liabilities to adjust or reverse them as needed when actual amounts are known.
Recommended: Guide to Financial Projections
The Takeaway
An accrued expense is an expense that is recorded before it has been paid. Listed under current liabilities on a company’s balance sheet, accrued expenses are recorded when they are incurred, even if the expense is actually paid in a different quarter.
If your small business has a lot of expenses, you may want to use accrual accounting vs. cash accounting, since it can help you keep better track of your total liabilities. Though it requires more work to do accrual accounting, recording accrued expenses generally makes financial statements more accurate.
GAAP prefers the accrual accounting method and, if you apply for any type of small business loan, the lender may ask for financial statements generated on an accrual basis.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How are accrued expenses recorded?
Companies record accrued expenses when they are incurred, not when they are paid. They appear on a company’s balance sheet as current liabilities.
What are some common accrued expenses?
Common accrued expenses include:
• Goods or services you’ve purchased but haven’t received an invoice for yet
• Bonuses, salaries, or wages payable
• Utility expenses that won’t be billed until the following month
• Unpaid interest expenses
Is rent an accrued expense?
Rent is typically a prepaid expense since you pay it in advance of receiving the benefit of the payment. If a company occupies a rented space but has not yet paid the rent due for that period, however, it would be an accrued expense.
How do accrued expenses affect a company’s financial health?
Accrued expenses impact a company’s financial health by increasing liabilities, which can reduce net income and affect short-term liquidity. While they reflect accurate accounting of incurred costs, excessive accruals may signal cash flow challenges, potentially raising concerns about the company’s ability to meet financial obligations.
What is the difference between accrued and accounts payable expenses?
Accrued expenses are costs a company has incurred but hasn’t yet been billed for, like wages or utilities. Accounts payable, on the other hand, are bills the company has received and agreed to pay. Both are liabilities, but accrued expenses are estimated, while accounts payable are based on actual invoices.
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