What is accrued expense?
An accrued expense is an accounting term referring to an expense that is owed but not yet paid for (also known as an accrued liability). For more on other kinds of liabilities, see the encyclopedia entry liability.
The accrued expense concept is one of several accounting conventions made necessary by the use of accrual accounting, in which revenues are recorded when earned and expenses are recorded when owed. Actual cash flow may occur at a different times.
At the end of an accounting period, for instance:
- A company may have purchased and received goods or services, but not yet paid for them because the seller offered a deferred payment plan (such as a "fly now, pay later" plan).
- A company may have incurred tax liabilities for earnings made during the period, but not yet paid.
- The company may owe its own employees salaries and wages for work performed, but not yet paid.
- The company may be repaying a loan and be mid way between payment due dates, meaning it already owes the lender more interest (for the part of the payment period already past), which will not be paid until the next loan payment is made.
These situations all represent accrued expenses, or equivalently, accrued liabilities.
- What is accrued expense?
- What is the meaning of accrued expense (accrued liability) in accounting? Example transaction.
- What is the role of accrued expense in prepayment and deferred payment situations?
- Is deferred expense possible in cash basis accounting?
What is the meaning of accrued expense (accrued liability) in accounting? Example transaction
Considering the as-yet unpaid employee salaries and wages, for instance, the bookkeeper's journal entries might appear like this at the end of the accounting period (account names and numbers refer to the example chart of accounts used throughout this encyclopedia):
Journal for Fiscal Year 20YY
720 Salary & wage expense
Salary and wage expense is an expense category account, so a debit entry increases this account balance by the debit amount. Payroll payable is a liability category account, so its account balance is increased by a credit entry (see Double-entry system for more explanation).
On the company's Income Statement for the period, the salary and wage expense will contribute to the rest of the salary and wage expenses for the period. All of these salary and wage expenses (including the expense incurred but not yet actually paid to employees) will be subtracted from the period's sales revenues, as part of the calculations for margins and profits.
On the company's Balance Sheet, however, the payroll payable entry will contribute to current liabilities. It might be added in under a higher level more general listing for accrued liabilities or, on a balance sheet with substantial detail, it might appear as a current liability item of its own, payroll payable.
When an accrued expense (accrued liability) is finally paid, bookkeeping journal entries may be as follows:
234 Payroll payable
Actual payment of the payroll due employers is recorded as a debit (decrease) to a liability account (here, the liability account is payroll payable), and a credit to an asset account (here, the asset account is cash, whose value is decreased by a credit entry).
What is the role of accrued expense in prepayment and deferred payment situations?
Accrued expenses (accrued liabilities) are handled in accrual accounting in much the same way some other revenue and expense transactions are handled when there is a time lapse between two parts of a business transaction.
Accrual accounting incorporates the matching concept, the idea that revenues should be recognized in the same period with the expenses that brought them. Prepayment and deferred payment situations present a special challenge to the company's bookkeepers and accountants, because it is possible for actual payment and actual delivery to fall in different accounting periods. In order to avoid violating the matching concept, bookkeepers make an initial two entries to register the first transaction event, and then, later, makes adjusting entries to register the second transaction event. For examples of journal entries for each kind of event, see the encyclopedia entries for individual terms, linked below.
Prepayments (payment precedes delivery of goods or services)
The prepayment situation occurs when delivery of goods or services precedes customer payment.
- From the seller's viewpoint: The seller will recognize unearned revenues (or deferred revenues) as revenues received for goods and services that have not yet been delivered. Unearned revenues are recorded as liabilities until such time as the goods and services are delivered, after which they may be recognized as earned revenues.
- From the buyer's viewpoint: The buyer recognizes deferred expenses (or prepaid expenses or deferred charges), when paying for services or goods before delivery. An inventory of postage stamps, bought but not yet used, is a prepaid expense. When taxes are paid in advance of due date, a prepaid expense is created. Prepaid expenses are recorded as a current asset until the services or goods are delivered or used.
Deferred payments (delivery of goods or services precedes payment)
The deferred payment situation occurs when delivery of goods or services precedes customer payment.
- From the seller's viewpoint: Accrued revenues (also called accrued assets or unrealized revenues) are revenues earned by the seller (for delivery of goods and services but which the seller has not yet received. Accrued revenues may be posted in one asset account, such as accounts receivable, until the revenues are actually received. Then, the accounts receivable account (an asset account) is credited (reduced) while the another asset account, cash, is debited (increased).
- From the buyer's viewpoint (the subject of this encyclopedia entry): Accrued expenses, or accrued liabilities are posted in the buyer's books as a liability, for goods and services purchased and received but not yet paid for. When workers are owed salaries or wages for work completed, but not yet paid for, the employer has an accrued expense. Interest payable for a bank loan can be an accrued expense. Accrued expenses are first entered in the journal as a liability until paid, at which time the liability account is debited (reduced) and an asset account, such as cash, is credited (decreased).
Is deferred expense possible in cash basis accounting?
For any company on a cash basis accounting system, however, the bookkeeping practice is much simpler. In cash basis accounting:
- Expenses are recognized when cash is paid
- Revenues are recognized when cash is received.
Accrued expenses (accrued liabilities) along with the other prepayment and deferred payment situations described above, are used in accrual accounting but not cash basis accounting.