Accrued expenses are where accrual accounting either clicks into place or stops making sense entirely. The name is part of the problem, because the balance sits on the balance sheet as a liability while the matching amount sits on the income statement as an expense. Once the entry is on the page, the rest of it follows.
What follows defines the term, works four entries end to end, draws the line between an accrued expense and an account payable, and explains why the entry is reversed at the start of the next period.
Key Takeaways
- An accrued expense is a cost that has been incurred and has not yet been billed or paid, and the cost is recorded in the period that consumed the cost rather than the period in which the invoice arrives.
- The entry always takes the same form: an expense account is debited and a liability account described as accrued expenses or accrued liabilities is credited.
- Accrued expenses and accounts payable are both liabilities, and the distinction between the two is whether a vendor invoice has been received.
- An accrued expense is reported as a liability on the balance sheet, notwithstanding that the word expense appears in the name of the account.
- Reversing the accrual on the first day of the following period prevents the same cost from being recorded twice when the invoice is eventually received.
Definition
An accrued expense is a cost that the business has already consumed and for which the business has not yet been billed and has not yet paid.
Employees worked during the final week of the month, electricity was consumed throughout the whole of the month, and interest accrued on the outstanding loan balance on every day of the month. None of those three costs has produced an invoice and none of those three costs has produced a payment, and all three of those costs are genuine costs of the period that has just closed. Accrual accounting requires that a cost is recorded in the period that consumed the cost, so the cost is recorded at the period end and the obligation is settled later.
Cash basis accounting takes the opposite approach and records a cost when the cost is paid. Cash basis accounting is simpler to operate, and cash basis accounting is also the reason a cash basis income statement can report an unusually profitable month followed immediately by an unusually poor month when nothing about the underlying business has changed except the timing of the payments.
The journal entry
Every accrual follows a single pattern.
| Account | Debit | Credit |
|---|---|---|
| Expense account such as wages, utilities or interest | X | |
| Accrued expenses, a liability account | X |
Scroll sideways to see all columns.
The debit records the cost in the period to which the cost belongs. The credit records the obligation of the business to pay the cost. When the invoice is received or the payment is made, the liability is cleared by a debit to the liability account and a corresponding credit is recorded to cash or to accounts payable.
Four worked entries
Accrued wages
A pay period closes on October 25 and the following payday falls on November 5. Employees worked four business days between October 26 and October 31, and daily payroll for the business amounts to $1,850. Four business days at $1,850 each produces $7,400 of wages that were consumed by October and were not paid by October.
| Date | Account | Debit | Credit |
|---|---|---|---|
| Oct 31 | Wages expense | $7,400.00 | |
| Oct 31 | Accrued wages payable | $7,400.00 |
Scroll sideways to see all columns.
Accrued wages are the most common accrued expense recorded by a small business and are also the accrued expense most often omitted. Omitting the accrual for wages transfers several days of labor cost into the wrong month, and the omission repeats in every month in which the accrual is omitted.
Accrued utilities
The December electricity bill covers electricity consumed during December and is not received until January 12, in the amount of $640.
| Date | Account | Debit | Credit |
|---|---|---|---|
| Dec 31 | Utilities expense | $640.00 | |
| Dec 31 | Accrued expenses | $640.00 |
Scroll sideways to see all columns.
Where the exact amount of the bill is not known at the period end, an accrual based on the bill for the corresponding month of the prior year, or based on an average of the three preceding months, is ordinary and is acceptable. The purpose of the accrual is that the cost is reported in the correct period, and the purpose of the accrual is not that the estimate is exact.
Accrued interest
A term loan of $50,000 carries annual interest of 7.5% and requires payments quarterly. One month of interest on a loan of $50,000 at an annual rate of 7.5% amounts to $312.50.
| Date | Account | Debit | Credit |
|---|---|---|---|
| Oct 31 | Interest expense | $312.50 | |
| Oct 31 | Accrued interest payable | $312.50 |
Scroll sideways to see all columns.
Interest accrues on every day the loan is outstanding, whether or not a payment falls due within the period, which is the reason a quarterly payment schedule still requires a monthly entry.
Accrued professional fees
An accountant performed work on the year end close throughout December and will not issue an invoice until February. An estimated $2,800 of the work performed belongs to December.
| Date | Account | Debit | Credit |
|---|---|---|---|
| Dec 31 | Professional fees | $2,800.00 | |
| Dec 31 | Accrued expenses | $2,800.00 |
Scroll sideways to see all columns.
Accrued expenses compared with accounts payable
Accrued expenses and accounts payable are both liabilities and both represent amounts owed by the business. The line between accrued expenses and accounts payable is whether a vendor invoice has been received.
| Accrued expenses | Accounts payable | |
|---|---|---|
| Invoice received | No | Yes |
| Amount | Frequently estimated | Exact, taken from the invoice |
| Created by | An adjusting entry at the period end | Entering a vendor bill |
| Typical duration | Days to weeks, until the invoice is received | Until the due date of the invoice |
| Examples | Wages, interest and utilities not yet billed | Vendor bills awaiting payment |
Scroll sideways to see all columns.
An accrued expense ordinarily becomes an account payable in the following period. An accrual of $640 is recorded for December electricity, the invoice is received during January, and the amount is then recorded as an ordinary account payable carrying a due date. Recording accrued expenses separately from accounts payable is what allows the business to see, at the period end, how much is owed in respect of costs for which no invoice has yet been issued. Where the payables queue is the point at which items are lost, bill management is the part of the workflow that warrants attention first.
Classification of an accrued expense
An accrued expense is a liability, and an accrued expense is reported within current liabilities on the balance sheet, ordinarily adjacent to accounts payable, under a caption such as accrued liabilities or accrued expenses.
The name of the account is the source of the confusion. The expense half of the transaction is reported on the income statement and reduces net income for the period. The accrued half of the transaction is reported on the balance sheet and represents an obligation of the business. The expense half and the accrued half are two sides of a single entry rather than two views of a single account.
Reversing entries
On the first day of the following period, the accrual is reversed. In the case of the wage accrual described above, the reversing entry is recorded on November 1 as a debit to accrued wages payable of $7,400 and a credit to wages expense of $7,400.
The purpose of the reversing entry becomes apparent when the payroll is processed on November 5. The entire gross payroll is recorded as wages expense in the ordinary way, without any requirement to identify the portion of the payroll that was accrued in the prior period. The reversing entry has already removed the overlap, and wages expense for November is therefore stated correctly.
The alternative to recording a reversing entry is to allocate every subsequent payment between the accrued portion and the current portion, on every occasion, without exception. Reversing entries exist because that allocation is not performed reliably.
Accruals are the entries that get skipped when the month end is already running late, and skipping them is what makes a set of books look profitable in one month and dreadful in the next. GlassJar carries the recurring accruals forward and reverses them for you, so the pattern holds without anyone having to remember it. See how it works.
Frequently asked questions
What are accrued expenses?
Accrued expenses are costs that a business has incurred and for which the business has not yet been billed and has not yet paid. Accrued expenses are recorded at the period end so that each cost is reported in the period that consumed the cost.
Is an accrued expense an asset or a liability?
An accrued expense is a liability and is reported within current liabilities on the balance sheet. The corresponding debit is recorded to an expense account on the income statement.
What is the journal entry for an accrued expense?
The relevant expense account is debited and the liability account described as accrued expenses or accrued liabilities is credited. When the invoice is received or the payment is made, the liability account is debited and cash or accounts payable is credited.
What is the difference between accrued expenses and accounts payable?
Accounts payable records amounts for which a vendor invoice has been received. Accrued expenses records amounts for which the cost has been incurred and no invoice has yet been received, which is the reason an accrued amount is frequently an estimate.
Do businesses on the cash basis record accrued expenses?
Businesses on the cash basis do not record accrued expenses. Cash basis accounting records an expense at the point the expense is paid, so no accrual arises. Accrued expenses apply only under the accrual method of accounting.
