Accrued Expense

What is an Accrued Expense?

An Accrued Expense is a liability that represents costs a business has incurred but not yet paid or recorded through normal invoicing. Under accrual accounting, these expenses are recognized when they occur, not when cash is disbursed, ensuring expenses are matched with related revenues in the same period.

Key Takeaways

• Accrued Expenses are costs incurred but unpaid at the balance sheet date.
• Common examples include wages payable, interest payable, and utilities payable.
• Recorded as current liabilities under the accrual basis of accounting.
• Ensure compliance with the matching principle by aligning costs with the revenues they support.
• Reversed at the start of the next accounting period once payments are made.

Understanding Accrued Expenses

Accrued expenses arise when a company incurs costs that have not yet been invoiced or settled in cash. This approach ensures that financial statements reflect economic reality, not just cash movements.

For example, if a company receives electricity in December but pays the bill in January, the expense is recognized in December under accrual accounting. This matches the cost with the period when the benefit (electricity usage) occurred.

Accrued expenses typically appear in the current liabilities section of the balance sheet and are reduced once the payment is made in the following period. They are essential for accurate financial reporting and performance measurement.

Formula (If Applicable)

While accrued expenses do not have a direct formula, they can be estimated as:

Accrued Expense = Incurred Expense – Amount Paid

For recurring costs, accountants often use time-based calculations, such as:

Daily Accrual = (Annual Expense × Days Accrued) / 365

Real-World Example

A company pays employee salaries of $100,000 on the 5th of each month for the previous month’s work. As of December 31, the company owes $100,000 in unpaid wages for December. The adjusting journal entry would be:

• Debit: Salaries Expense $100,000
• Credit: Salaries Payable $100,000

When the company pays employees on January 5, it reverses the accrual:

• Debit: Salaries Payable $100,000
• Credit: Cash $100,000

This ensures expenses are recorded in the correct accounting period.

Importance in Business or Economics

Accrued expenses play a critical role in ensuring accurate financial reporting, tax compliance, and performance evaluation. They help:

• Reflect true operational costs within the correct period.
• Maintain alignment with accrual accounting standards (GAAP/IFRS).
• Support budgeting and forecasting accuracy.
• Improve liquidity management by identifying upcoming obligations.

In economic analysis, accrued expenses influence corporate liability estimates and short-term solvency assessments.

Types or Variations

• Accrued Wages: Employee salaries incurred but unpaid.
• Accrued Interest: Interest expense accumulated on loans or bonds but not yet paid.
• Accrued Taxes: Income or property taxes owed but not settled.
• Accrued Rent or Utilities: Costs incurred for facilities or services not yet billed.

Related Terms

• Accrued Liability
• Accounts Payable (AP)
• Accrual Accounting
• Deferred Expense
• Matching Principle

Sources and Further Reading

• Financial Accounting Standards Board (FASB): https://www.fasb.org
• IFRS Foundation – Accrued Liabilities: https://www.ifrs.org
• Investopedia – Accrued Expense: https://www.investopedia.com/terms/a/accruedexpense.asp

Quick Reference

• Category: Current Liability.
• Basis: Accrual Accounting.
• Purpose: Record unpaid expenses in the correct period.
• Examples: Wages, interest, utilities, and taxes.
• Effect: Increases liabilities and decreases net income.

Frequently Asked Questions (FAQs)

How are accrued expenses recorded?
By debiting the relevant expense account and crediting an accrued liability account.

Are accrued expenses the same as accounts payable?
Not exactly. Accounts payable arise from billed invoices, while accrued expenses represent costs not yet invoiced.

Why are accrued expenses important?
They ensure expenses are matched with revenues, improving accuracy in financial statements.

When are accrued expenses reversed?
At the start of the following accounting period, when the actual payment is made.