It’s key to separate accrued expenses from accounts payable. While both represent money that will be spent, they are not identical. Accounts payable are short-term expenses that must be paid because an invoice has been submitted. Accrued expenses are costs that are known to exist even though no invoice has yet been submitted. Your company gets the benefit of space, heat, and employee labor for up to a month before you receive an invoice or pay for them. If you are using an accrual method of accounting, you’ll record those expenses as you receive the benefits you’ll be paying for. If you’re using a cash method of accounting, however, you won’t record those expenses until cash goes out the door to pay for them. Another example of accrued expense is a product or service that already has arrived and been used before it’s been invoiced or paid for; for example, a repair is made to your printer, but no invoice has yet been sent for the repair work. Of course, you owe the repair shop money regardless of whether the invoice has arrived, so the repair is an accrued expense.
How Accrued Expenses Work
If you’re a large U.S. publicly traded corporation, you’re required to use the accrual accounting method and show your accrued expenses at all times. This requirement is part of the federally mandated Generally Accepted Accounting Principles, known as GAAP, and it’s considered an important way to maintain ethical accounting practices. If you’re a small private business, however, GAAP doesn’t apply, so you can choose between showing or not showing your accrued expenses in your financial records. Imagine you run a small business that sells jewelry from a storefront. You have a store manager who is paid $2,000 at the end of each month, a cleaning service that forgets to bill you but charges $200 per month, and a $150 electricity bill coming soon. Your jewelry maker shipped you an order valued at $1,000, but the invoice got lost in the mail. All of these are accrued expenses. If you use the cash method of accounting, you will have entered none of these expenses into your accounting software. After all, no money has changed hands yet. This keeps things simple, but it also suggests you have an extra $3,350 available—which you might spend without realizing it’s already been spent. If you use the accrual accounting method, you will have accounted for all those expenses before they are paid out.
title: “What Are Accrued Expenses " ShowToc: true date: “2023-01-16” author: “Susan Muffley”
Understanding how accrued expenses work can help you streamline your company’s operations, budget efficiently, and maintain easily accessible records for filing tax deductions.
Definition and Examples of Accrued Expenses
Accrued expenses are business expenses that have been incurred in one accounting period but won’t be paid until the next period. These are different from accounts payable because the invoices for them have not yet been received or entered into the payment system. These are expenses for goods or services that your business has purchased and will eventually have to pay. You have to take them into account when planning your budget and other expenses, even if they haven’t yet been invoiced. This way, you can make sure you don’t accidentally spend the money you will need to pay these expenses. “They are also known as ‘accrued liabilities’ as the business is liable (i.e., they are obligated to pay…) for them, even though the goods or services have not yet been delivered or billed,” JC Glancy of ZenBusiness told The Balance via email.
Alternate names: Accrued charges, accrued liabilities, accrued costs, accrued expenditures
For instance, “Subscription services (e.g., domain registration renewals, software subscription services, email marketing, etc.) for which invoices have not been generated by the end of your accounting period can be an example of frequent accrued expenses,” Daniel Kroytor, president of TailoredPay, an online card processing service, told The Balance via email. Other examples of accrued expenses include:
Tax payments that aren’t immediately dueEmployee wages that need to be paid by the first or second of the next monthContractor or freelancer fees that haven’t yet been invoiced
How Accrued Expenses Work
Accrued expenses are recorded on your company’s balance sheet as current liabilities to be paid now or in the near future. When your company purchases goods or services (or is scheduled to make one), your accounts department makes a note of this liability in the in-house finance management system. These may be estimates until you receive a final invoice with the official expense totals. Glancy offers a helpful example to better explain how the accrual process works. “On Sept. 1, you have a contract with a window cleaner to clean your windows two times a month. By Sept. 30, you have not received the invoice from the window cleaner for the service or paid the bill. To be able to account for that expense, you will need to record the expense as an accrual,” Glancy said. This internally recorded expense is an accrued expense until it is paid.
Types of Accrued Expenses
Even very different types of businesses often have similar kinds of accrued expenses. Here are some common categories to keep in mind for your small-business accounting. Here are some key differences to keep in mind.
Pros Explained
Better planning: Tracking accrued expenses can help you understand your business transactions better. This allows you to more accurately plan and manage your small business’s finances.Accurate representation: Accrued expenses offer a realistic picture of your company’s assets and liabilities. This gives a more accurate representation of how your company performed in the given time period.
Cons Explained
Margin for errors: The total amount owed as an accrued expense is often estimated rather than exact. This means there is a margin for error in your accounting.Requires more resources: Setting up a system to record accrued expenses requires hiring, training, and team supervision. This setup could require your team’s time and resources.
