What Are Accrued Expenses? Definition and Examples

Accrued expenses represent a fundamental concept in financial accounting, reflecting costs a business has incurred even though cash has not yet been paid or a formal invoice received. This accounting treatment is central to the accrual basis of accounting, which aims to match expenses to the period in which they are incurred, regardless of when payment occurs. By recognizing these obligations promptly, businesses can present a more accurate financial picture for a specific reporting period.

Defining Accrued Expenses

An accrued expense signifies a liability for goods or services that a business has already received or utilized, but for which the payment is not yet due or an invoice has not been processed. This concept is distinct from an “accounts payable,” where an invoice has already been received, formalizing the debt. Accrued expenses are recorded to align with the accrual basis of accounting, recognizing expenses when they arise, irrespective of the cash exchange date, and linking them to the revenue they help generate.

When the exact cost is unknown, an accrued expense is typically an estimated amount, which must be a reasonable approximation. Unlike “prepaid expenses,” which involve payments made in advance for future goods or services, accrued expenses reflect a past consumption or receipt of benefit for which payment is pending. Recording these liabilities ensures that financial statements, particularly the income statement and balance sheet, accurately portray the company’s financial position and obligations at the end of an accounting period.

Recording Accrued Expenses

Recording accrued expenses involves a double-entry accounting process to ensure financial records remain balanced. When an expense is incurred but not yet paid, the accounting system recognizes this by debiting the relevant expense account, increasing total expenses reported on the income statement for that period.

Simultaneously, a credit is made to an accrued liability account, such as “Accrued Wages Payable” or “Accrued Interest Payable,” on the balance sheet. This credit increases the company’s liabilities, reflecting the outstanding obligation to pay in the future. The accrued liability account serves as a temporary placeholder, acknowledging the debt until the actual payment is made, ensuring the expense is matched to the correct accounting period.

Common Examples of Accrued Expenses

Accrued salaries and wages are a typical example, occurring when employees have performed work up to the end of an accounting period, but their payday falls into the subsequent period. The wages earned are an expense for the current period, even though payment will be made later. Similarly, accrued interest arises on loans or credit lines where interest has accumulated over a period but is not yet due for payment.

Utilities, such as electricity, water, or gas, are also common accrued expenses. Companies often use these services throughout a month but receive the bill in the following month, necessitating an accrual for the services consumed. Accrued rent can occur if rent is incurred for a period but the payment date falls after the accounting period closes.

Reversing Accrued Expenses

Accrued expense entries are often reversed at the beginning of the subsequent accounting period. This reversal simplifies recording the actual payment and prevents the expense from being double-counted. Without a reversal, the expense might be recorded again when the actual invoice arrives and payment is made, leading to an overstatement.

The reversal involves debiting the accrued liability account, which removes the temporary liability from the balance sheet, and crediting the original expense account. When the actual bill is received and paid, the normal cash payment entry is recorded, typically involving debiting the expense account for the actual amount and crediting the cash account, ensuring accurate financial records.