What Is an Example of an Accrued Expense?

Understanding Accrued Expenses

An accrued expense represents a cost that a business has incurred but has not yet paid or officially recorded in its accounting books. These are obligations for goods or services that have already been received or consumed by the company. Recognizing these expenses is important for accurate financial reporting, especially under the accrual basis of accounting, which aims to match expenses with the revenues they help generate.

Accrued expenses exist because of the matching principle, a fundamental concept in accrual accounting. This principle dictates that expenses should be recognized in the same accounting period as the revenues they helped generate, regardless of when the actual cash payment occurs. Businesses continuously incur costs as they operate, even if an invoice has not yet arrived or payment is not immediately due.

For example, employees earn wages daily, but payroll might be processed only bi-weekly or monthly. The company has received the benefit of their labor, incurring the expense, before the cash outflow. Accrued expenses are characterized by the consumption of a service or benefit before the cash exchange, and they represent a short-term liability on a company’s balance sheet.

This liability signifies an amount owed for past activities, reflecting a future cash obligation. Properly recording these expenses ensures that a company’s financial statements accurately reflect its financial performance and position for a given period. It prevents understatement of liabilities and overstatement of profits, providing a true picture of the business’s financial health.

Common Examples of Accrued Expenses

One common example is accrued salaries and wages. Employees work throughout a pay period, earning their compensation each day they perform services. However, the actual payday often falls after the end of an accounting period. The company has incurred the expense for the work performed, even though the cash payment will be made at a later date.

Accrued interest expense is another instance. Businesses frequently borrow money, and interest on these loans accumulates over time. While interest payments might only be due quarterly or semi-annually, the interest expense is incurred daily as the loan balance remains outstanding.

Accrued utilities are another example. Services such as electricity, water, and gas are consumed by a business throughout a month. The utility bill typically arrives and is paid in the following month, after the services have already been used. The company has benefited from these services, incurring the expense before receiving the invoice or making the payment.

Accrued rent expense can arise when a business pays rent on its facilities. Although rent is often paid monthly, situations can occur where a portion of rent for the accounting period has been incurred but not yet paid. This could happen if a company closes its books mid-month, or if rent is paid in arrears, meaning after the usage period.

Accrued professional fees are common. Companies frequently engage external professionals like lawyers or accountants for ongoing services. These professionals may bill periodically, such as monthly or upon project completion. If services have been rendered by the end of an accounting period but an invoice has not yet been received or paid, the cost of those services becomes an accrued professional fee.

Recording Accrued Expenses

Recording an accrued expense involves a basic journal entry to recognize the cost in the proper accounting period. This entry involves debiting an expense account, increasing expenses on the income statement, and crediting a liability account, establishing a payable on the balance sheet.

For instance, to record accrued salaries, a company would debit “Salaries Expense” to reflect the cost of labor incurred. A corresponding credit is made to “Accrued Salaries Payable,” creating a liability for the amount owed to employees. This ensures the income statement accurately reflects labor costs and the balance sheet shows the outstanding obligation.

Similarly, for accrued interest, “Interest Expense” would be debited to capture the cost of borrowing for the period. A corresponding credit is made to “Accrued Interest Payable,” establishing the liability for interest owed. This entry ensures the expense is recognized when incurred.

When the accrued expense is paid, a second journal entry is performed. This involves debiting the liability account to reduce the payable, removing the obligation from the balance sheet. Simultaneously, the company’s cash account is credited, decreasing its cash balance.

For example, when accrued salaries are paid, “Accrued Salaries Payable” is debited and “Cash” is credited. This two-step process ensures expenses are recognized when incurred and liabilities are cleared once paid, completing the accounting cycle for that specific accrued expense.