The accrued expense concept is one of several accounting conventions that become necessary when the firm uses accrual accounting. In accrual accounting, firms record revenues when they earn them, and expenses when they owe them.
The accrual definitions for "earn" and "owe" ensure that firms report revenue earnings along with the expenses that bring them, in the same accounting period. The actual cash that follows from these events may occur at different times.
During an accounting period, for instance:
- A company may purchase and receive goods before it pays for them. This payment timing occurs, for example, when customers buy "on credit"—credit the seller issues. The same timing also occurs when sellers offer deferred payment as "Fly now, pay later" plans. In both cases, the seller has accrued revenues, and the buyer has accrued expenses.
- A company may incur tax liabilities for earnings made during the period. These liabilities are accrued expenses until the company pays them.
- The company may owe its own employees salaries and wages for work performed, but not yet paid. Salaries and wages owed in this way are accrued expenses.
- The company may be repaying a loan and be midway between payment due dates. In this case, it already owes the lender more interest than it has paid, for the portion of the current payment period already past. These funds are "deferred expenses" until the company makes the next interest payment.
Explaining Accrued Expense in Context
Accrual accounting uses quite a few similar-sounding terms to classify the results of accruing and deferring payments. To avoid confusion, therefore, the following sections explain "accrued expense" in the broader context of related terms, including the following:
Accrual accounting uses several similar-sounding terms to classify the results of accruing and deferring payments. To avoid confusion, the following sections explain Accrued Expense in context with related concepts, emphasizing four themes:
- First, how accountants define Accrued Expense, along with similar terms such as Deferred Payment, Accrued Assets, and Accrued Liabilities.
- Second, how accrual concepts implement the Matching Concept in Accounting.
- Third, example transactions that Accrue Expenses for buyers.
- Fourth, how expense accrual impacts other accrual concepts, such as Accrued Revenue, Unrealized Revenue, and Deferred Charge.
- What is accrued expense?
- Why are accrued expenses necessary in accrual accounting?
- The matching concept in accrual accounting
- How do deferred expenses enter the accounting system? Example journal transactions.
- How do deferred expenses impact financial statements?
- Are accrued expenses possible in cash basis accounting?
- See Accrual Accounting for an explanation of accrual accounting principles.
- For more example transactions illustrating accrual concepts, see the individual articles:
Accountants handle "accrued expenses" ("accrued liabilities") in much the same way they treat other revenue and expense transactions when there is a time lapse between two parts of a business transaction.
The Matching Concept in Accrual Accounting
Accrual accounting incorporates the matching concept, the idea that firms must recognize revenues in the same period they report the expenses that bring them. Prepayment and deferred payment situations present a particular challenge to accountants, however, when actual payment and actual delivery fall in different accounting periods.
Both firms apply the matching concept by registering the first transaction event, immediately, with two entries in their account system journals. Then, later, each makes another pair of journal entries to record the second transaction event.
Results of the First Sales Transaction Event
Exhibit 1 and 2, below, show the accounting results that follow from a purchase transaction. One event in this transaction is customer payment, and the other is seller delivery of the purchase. Either of the two may precede the other.
Exhibit 1 shows the possible accounting results from a sale after just one of the two sale transaction events occurs.
|After First Sales
|When Payment Precedes Delivery||When Delivery precedes Payment|
|The Seller Has:||"Unearned Revenue"
|The Buyer Has:||"Deferred Expense"
|Exhibit 1. Accrual accounting results after the first sales transaction event. The terms in each cell are interchangeable.|
Prepayment: What Happens When Payment Precedes Delivery?
The prepayment situation occurs when delivery of goods or services precedes customer payment.
- Seller's viewpoint:
The seller recognizes unearned revenues (or deferred revenues) for goods and services the seller has not yet delivered. Revenue receipt is the first sales transaction event.
Sellers record "Unearned revenues" as liabilities until the second event in the sale, when they deliver goods or services. After delivery, the seller claims the same funds as revenue earnings.
- 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 used yet, is a prepaid expense. When a firm pays taxes in before they are due, the firm creates a "prepaid expense."
Buyers carry prepaid expenses as Current Assets until the services or goods are delivered or used. After delivery, these assets transform into ordinary "expenses."
Deferred Payment: What Happens When Delivery Precedes Payment?
The deferred payment situation occurs when delivery of goods or services precedes customer payment.
- Seller's viewpoint:
"Accrued revenues" (also called "accrued assets" or unrealized revenues) are revenues earned by the seller for delivery of goods and services before the customer pays for them. Before receiving payment, the seller may post these revenues in an asset account, such as Accounts Receivable.
When the customer pays, the seller credits (reduces) Accounts Receivable and credits (increases) another asset account, Cash.
- Buyer's viewpoint (the subject of this article):
The buyer posts an "accrued expense" or "accrued liability" as a liability, for goods and services purchased and received but not paid for yet. 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. In any case, "accrued expenses" enter the journal as liabilities where they remain until paid.
When the buyer pays, the buyer debits (decreases) the liability account and at the same time credits (decreases) an asset account, such as Cash.
Results of the second sales transaction event
Exhibit 2, below, shows the results after the second sales transaction event.
|After the Second Sales
|When Payment Precedes Delivery||When Delivery Precedes Payment|
|The Seller Has:||Sales Revenue Earnings||Sales Revenue Earnings|
|The Buyer Has:||Expenses Paid||Expenses Paid|
|Exhibit 2. Accrual accounting results after the second sales transaction event.|
Considering the as-yet unpaid employee salaries and wages, for instance, the bookkeeper's journal entries at the end of the accounting period might appear as in Exhibit 3:
Journal for Fiscal Year 20YY
720 Salary & wage expense
|Exhibit 3. Journal entries for employee salaries and wages owed but not yet paid.|
Note that account names and numbers refer to the example Chart of Accounts appearing throughout this encyclopedia.
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 increases with a credit entry (see Double-Entry System for more on debit and credit impacts in different accounts).
On the company's Income Statement for the period, the salary and wage expense will contribute to the total salary and wage expenses for the period. The firm will subtract all of the period's salary and wage expenses (including those incurred but not yet actually paid to employees) 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. On a Balance sheet with high detail, It might add to a higher level listing for "accrued liabilities" or, on a detailed Balance sheet, it might appear as a Current Liability item of its own, Payroll payable.
When the customer finally pays an "accrued expense" ("accrued liability"), bookkeeping journal entries may appear as follows:
234 Payroll payable
|Exhibit 4. Journal entries for employee salaries and wages owed after the employer pays them.|
Firms record the actual payment of payroll payable as a debit (reduction) to a liability account (here, the liability account is Payroll Payable), and at the same time, a credit (decrease) to an asset account such as Cash.
For any company on a cash basis accounting system, however, the bookkeeping practice is more straightforward. In cash basis accounting:
- The firm recognizes expenses only when it pays cash.
- The firm recognizes revenue earnings only when it receives cash.
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.