What Is an Accrued Expense? Definition & Examples

Accrued expenses are a fundamental concept in financial reporting, representing costs a business has incurred but not yet paid. These expenses are recognized in financial records when they arise, regardless of when the cash transaction takes place. This accounting practice provides a complete and accurate view of a company’s financial obligations and performance.

Defining Accrued Expenses

An accrued expense is a liability for a cost a company has incurred during a specific accounting period, even though payment has not yet been made. This means goods or services have been received, but an invoice may not have been issued. Recognizing these expenses is a core component of accrual basis accounting, which records financial transactions when they happen, rather than when cash changes hands. This method allows businesses to accurately reflect their financial position and performance.

Accrued expenses are recorded as a liability on a company’s balance sheet, indicating a future payment commitment. This reflects the obligation to pay for services or goods already consumed. This recognition aligns with the principle that financial statements should present a clear picture of what a company owes.

Why Accrued Expenses Are Important

Recognizing accrued expenses accurately portrays a company’s financial health. This practice ensures that expenses are recorded in the same accounting period as the revenues they helped generate. This alignment, known as the matching principle, is a core aspect of accrual accounting. By matching expenses with associated revenues, financial statements provide a precise representation of a company’s profitability.

Properly accounting for accrued expenses helps prevent overstating profits in one period and understating them in another. It ensures that the income statement accurately reflects operational costs for the period. Including accrued expenses on the balance sheet provides a comprehensive view of a company’s liabilities, important for budgeting and financial planning.

Common Accrued Expense Examples

Common business activities frequently result in accrued expenses. One widespread example is accrued salaries and wages, where employees earn compensation for work performed within an accounting period, but payment occurs in the subsequent period. Utilities, such as electricity or water, often fall into this category, with usage occurring in one month and the bill paid in the next.

Interest on loans also represents a common accrued expense, as interest accumulates daily or monthly but may only be paid quarterly or annually. Similarly, rent can be an accrued expense if a business occupies a property for a period before the rent payment is due. Taxes, such as property or income taxes, can accrue over time even if payments are made on a less frequent schedule.

Recording Accrued Expenses

Recording accrued expenses involves an accounting procedure to reflect the incurred cost and the corresponding obligation. When an expense is incurred but not yet paid, an accounting entry acknowledges both the expense and the liability. This involves debiting an expense account to increase the recorded cost for the period.

Concurrently, a credit is made to an accrued liability account, which appears on the balance sheet. This credit increases the company’s liabilities, signifying the amount owed. For instance, if employees earn $10,000 in wages in December but are paid in January, the company debits “Wage Expense” and credits “Wages Payable” in December. This entry ensures the expense is recognized in the period it was incurred.

Accrued Expenses Versus Other Liabilities

Accrued expenses differ from other common liabilities like accounts payable and prepaid expenses, in timing and the nature of the obligation. Accrued expenses represent costs incurred where no invoice has been received, or payment is due later. They are recognized at the end of an accounting period to reflect obligations that have built up over time.

Accounts payable, in contrast, are obligations for which a company has already received an invoice for goods or services. While both are current liabilities, accounts payable typically have defined payment terms and represent a formal record of bills received but not yet paid. The key difference is the presence of an invoice for accounts payable, and its absence for accrued expenses.

Prepaid expenses are the opposite of accrued expenses. They represent payments made in advance for goods or services that will be received or consumed in a future accounting period. Unlike accrued expenses, which are liabilities, prepaid expenses are initially recorded as assets because they represent a future economic benefit. As the benefit is consumed, the prepaid asset is gradually recognized as an expense.