Is an Accrued Expense an Asset or a Liability?
Understand why accrued expenses are a key liability in financial statements, not an asset. Get clear insights into their accounting treatment.
Accrued expenses are a common element in financial reporting. This article clarifies their nature and how they are accounted for in a business’s financial statements.
Understanding Accrued Expenses
Accrued expenses arise from the application of accrual basis accounting, a method that recognizes revenues and expenses when they are earned or incurred, regardless of when cash changes hands. This approach provides a more accurate picture of a company’s financial performance during a specific period. An accrued expense, therefore, is an expense that a business has incurred but has not yet paid.
These expenses represent obligations for goods or services that have been received, even though the invoice may not have arrived or the payment due date has not yet occurred. Common examples include employee salaries and wages earned but not yet disbursed, utility services consumed before the bill is received, or interest accumulated on a loan since the last payment.
When a company incurs an expense, it assumes an obligation to pay for the benefit received. This obligation exists independently of whether the company has received a formal bill or made the payment. Accrued expenses are therefore recognized to ensure that all costs associated with generating revenue in a given period are properly matched against that revenue. This adherence to the matching principle of accounting ensures that financial statements accurately reflect a company’s profitability.
Why Accrued Expenses Are Liabilities
Accrued expenses are classified as liabilities on a company’s balance sheet, not as assets. A liability represents a present obligation of an entity to transfer economic benefits as a result of past transactions or events. This aligns with an accrued expense, as the company has already received the benefit (e.g., employee labor, electricity usage) and has a commitment to pay cash or provide other economic resources in the future.
Conversely, an asset is defined as a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Accrued expenses do not provide future economic benefits; instead, they represent a drain on future economic benefits as they require a future outflow of cash or other resources. For example, while employees provide a service, the accrued salary is the obligation for that service, not the service itself as a future benefit.
Accrued expenses fit the definition of a liability because they are obligations that will require settlement through a future outflow of resources. These obligations are typically classified as current liabilities, meaning they are expected to be settled within one year or one operating cycle, whichever is longer.
Recording Accrued Expenses
The recording of accrued expenses is a key part of the adjusting entry process in accrual basis accounting. At the end of an accounting period, before financial statements are prepared, companies make adjusting entries to ensure all revenues and expenses are recognized in the proper period. For an accrued expense, this involves recognizing both the expense and the corresponding liability.
The typical journal entry to record an accrued expense involves debiting an expense account, which increases the expense on the income statement, and crediting an accrued expense liability account, which increases a current liability on the balance sheet. For instance, if employees have earned $10,000 in wages but have not yet been paid at month-end, the company would debit Wages Expense for $10,000 and credit Accrued Wages Payable for $10,000. This entry ensures the income statement reflects the full cost of labor incurred during the period.
This accounting treatment directly impacts both the income statement and the balance sheet. The debit to the expense account increases total expenses, thereby reducing reported net income for the period. Simultaneously, the credit to the accrued liability account increases the company’s total liabilities, reflecting the obligation to make a future payment. When the actual cash payment is made, the accrued liability account is debited, and the cash account is credited, thereby reducing both the liability and the cash balance.