What Is Accrued Expenses on a Balance Sheet?

Accrued expenses are a common component of a company’s financial records, appearing on its balance sheet. They represent financial obligations a business has incurred for goods or services already received or consumed, but for which payment has not yet been made or formally invoiced. Understanding accrued expenses is important for accurately assessing a company’s financial position and performance. This article explains what accrued expenses are, their significance, common examples, and how they are recorded and settled.

What Accrued Expenses Are

Accrued expenses are liabilities a company records on its balance sheet for costs incurred but not yet paid or formally billed. These expenses reflect economic obligations for benefits already received, even if the cash outflow has not occurred. They are a direct result of the accrual basis of accounting, which mandates that expenses be recognized when incurred, regardless of when cash is exchanged.

Accrued expenses differ from accounts payable, which arise when a company receives a formal invoice for goods or services. Accrued expenses represent obligations for which an invoice has not yet been received, or payment is due at a later date. They are essentially estimated liabilities, reflecting amounts owed for services or goods consumed, such as salaries earned by employees or utilities used, before the official bill arrives.

Why Accrued Expenses Appear on the Balance Sheet

The inclusion of accrued expenses on the balance sheet is fundamental to accrual basis accounting, which aims to provide a comprehensive and accurate view of a company’s financial health. This method ensures that financial statements reflect the actual economic activities of a business during a specific period.

A core principle underlying this is the matching principle, which dictates that expenses should be recognized in the same accounting period as the revenues they helped generate. For instance, if a company uses electricity in June to produce goods sold in June, the cost of that electricity must be recorded in June, even if the utility bill arrives in July.

Recording accrued expenses impacts both the balance sheet and the income statement. On the balance sheet, they are classified as current liabilities. On the income statement, these amounts are recognized as expenses, reducing reported net income for the period. Without recording accrued expenses, a company’s liabilities would be understated, and its expenses would appear lower, leading to an overstatement of its profitability.

Common Examples of Accrued Expenses

Many routine business operations lead to accrued expenses, which are incurred continuously but paid periodically. Accrued wages and salaries are a common example, as employees earn their pay each day, but companies typically process payroll on a bi-weekly or monthly schedule. The wages earned by employees between the last payday and the end of an accounting period, but not yet paid, constitute an accrued expense.

Accrued interest is another frequent occurrence, particularly for businesses with loans or lines of credit. Interest on debt often accrues daily or monthly, even if payments are only due quarterly or semi-annually. The interest that has accumulated but not yet been paid by the end of a reporting period is recorded as an accrued expense. Similarly, utility services like electricity, water, and gas are consumed continuously, but bills are usually received weeks later. The estimated cost of utilities used but not yet billed or paid at the period-end is recognized as an accrued expense.

Accrued rent can also arise, especially when rent payments are made in arrears or cover a period that spans across two accounting periods. If a company occupies a space throughout a month but pays rent on the first day of the following month, the rent expense for the current month is accrued. These examples highlight how businesses incur obligations for services and resources before the actual payment transaction occurs.

Recording and Settling Accrued Expenses

Accrued expenses are recognized through an adjusting journal entry at the close of an accounting period. This entry involves debiting the relevant expense account and crediting an accrued liability account, which increases the company’s liabilities on the balance sheet. This process ensures that the expenses are matched to the period in which they were incurred, even if an invoice has not yet been received. For instance, if employees have earned wages that will be paid in the next period, the company records a wage expense and an accrued wages payable liability.

When the actual payment is made, or the invoice is received and processed, the accrued liability is then settled. This involves debiting the accrued expense liability account to reduce the liability, and crediting the cash account to reflect the outflow of funds. Accrued expenses are generally classified as current liabilities, signifying that they are expected to be paid within one year from the balance sheet date.