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Accrued Expenses: Defined and Explained

Accrued Expenses: Defined and Explained
Lauren Ward
Lauren WardUpdated January 5, 2023
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Accrued expenses are goods and services a company has received but hasn’t paid for yet. Even though no cash has exchanged hands, a company will account for accrued expenses in the budget. This type of accounting, called the accrual method, allows a company’s financial statements, such as the balance sheet and income statement, to be more accurate.Read on for an in-depth look at accrued expenses, including what they are, examples of accrued expenses, plus how accrual accounting compares to other accounting methods.

What Are Accrued Expenses?

By definition, accrued expenses are expenses a company accounts for when they happen, as opposed to when they are actually invoiced or paid for. An example of an accrued expense is when a company purchases supplies from a vendor and has not yet received an invoice or paid for the purchase. Other examples include employee wages, commissions, and bonuses – these costs accrue in the period they occur even though the actual payment is made in the following period.Tracking accrued expenses is important because they represent a liability (money that must eventually be paid out) for your company and can significantly impact your cash flow and key financial statements.

How Accrued Expenses Work

With an accrued expense there is no documentation of the expenditure – at least not yet. In place of that documentation, a bookkeeper or owner will create a journal entry to record an accrued expense, as well as an offsetting liability. If no journal entry was made, the expense would not appear in any of the company’s financial statements for that period. This could result in reported profits being too high in that period. Reporting accrued expenses helps increase the accuracy of financial statements, so that expenses are more closely aligned with the revenues they are associated with. In some cases, accrued expenses will be an estimated amount of what's owed. This is then adjusted later to the exact amount, once the invoice has been received.Since accrued expenses represent a company's obligation to make future cash payments, they are recorded on a business’s balance sheet as current liabilities.Recommended: What is Trade Credit and How Does it Work? 

Can Accrued Expenses Prevent A Business From Getting Approved for a Small Business Loan? 

Not necessarily. There are many variables lenders look at when a company applies for a business loan. These include:A large amount of accrued expenses can affect a company’s cash flow, which is important because it reflects how well a company will be able to keep up with monthly payments. If a company has too many liabilities, then it suggests to a lender that it might struggle if it sees a drop in revenue or rise in overhead expenses.

Accrual vs Cash Basis Accounting

There are some key differences between cash vs. accrual accountingCash basis accounting records money and expenses when money is actually received or paid. Accrual accounting, by contrast, records money and expenses when they are earned or incurred. Therefore, even though money or bills may be received in a different reporting period, they are recorded at the moment they are received. Accrual basis of accounting is in accordance with the Generally Accepted Accounting Principles (GAAP), whereas cash basis accounting is not.Here’s a side-by-side comparison of cash basis accounting vs accrual accounting. 
Cash Basis AccountingAccrual Accounting
Revenue is recorded when it is earnedX
Revenue is recorded when it is receivedX
Expenses are recorded when money is paidX
Expenses are recorded before money is paidX
Often used by small businessesX
Provides a more accurate picture of profitabilityX
Can provide inaccurate view of bank fundsX
Required of companies following GAAPX

Accrued Expenses Examples

Some examples of the accrued expenses that your company might need to track include:
  • Employee wages
  • Services received
  • Interest on small business loans
  • Taxes
  • Utility bills
  • Computer equipment
  • Office supplies
Let’s take a closer look at office supplies to get a more detailed example of an accrued expense. Let’s say your company receives office supplies from a supplier on June 25th. The invoice (expected to be $600), however, doesn’t come in before you close the company’s books for June. To record this accrued expense in the month you received it, you would record a debit of $600 to the office supplies expense account and a credit of $600 to the accrued expenses liability account. When you later receive the supplier invoice for $600, you would record it through the accounts payable module of your small business accounting software. This results in a debit to the office supplies expense account and a credit to the accounts payable account. As a result, there is no new expense recognition the following month.

Prepaid vs Accrued Expenses

Prepaid expenses are the opposite of accrued expenses. With accrued expenses, the company has received goods and services but has not yet paid for them. With prepaid expenses, the company pays for goods and services it has not yet received but expects to receive or use in the future. While accrued expenses represent liabilities, prepaid expenses are recognized as assets on the balance sheet. That’s because the company expects to receive future economic benefit from the prepayment.Here’s a closer look at prepaid expenses vs. accrued expenses.
Prepaid ExpensesAccrued Expenses
Payment is made before any goods or services have been receivedX
Recorded as a current asset on a balance sheetX
Recorded as a current liability on a balance sheetX
Payment is made after goods or services are receivedX

Accrued Expenses on a Balance Sheet

Accrued expenses are recorded on a company’s balance sheet, which shows what a company owns (its assets) and owes (its liabilities) as of a particular date, along with its owners’ equity. Accrued expenses are recorded under current liabilities, which are a company's financial obligations that are due within one year or within a normal operating cycle.

Recording Accrued Expenses

With accrued expenses, you typically accrue a liability in one period and pay the expense in the next period. That means you enter the liability in your books at the end of an accounting period. Then in the next period, you reverse the accrued liabilities journal entry when you pay the debt. This shows the expense paid instead of a debt owed.Keep in mind that you only deal with accrued liabilities if you use accrual accounting. Under the accrual method, you record expenses as you incur them, not when you exchange cash. With cash basis accounting, on the other hand, you only record transactions when cash changes hands.Recommended: Small Business Accounting Basics 

The Takeaway

An accrued expense is an expense that is recorded before it has been paid. Listed under current liabilities on a company’s balance sheet, accrued expenses are recorded when they are incurred, even if the expense is actually paid in a different quarter. If your small business has a lot of expenses, you may want to use accrual accounting vs. cash accounting, since it can help you keep better track of your total liabilities. Though it requires more work to do accrual accounting, recording accrued expenses generally makes financial statements more accurate. GAAP prefers the accrual accounting method and, if you apply for any type of small business loan, the lender may ask for financial statements generated on an accrual basis.

3 Small Business Loan Tips

  1. Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can compare small business loans by filling out one application on Lantern by SoFi.
  2. If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
  3. If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

Frequently Asked Questions

How are accrued expenses recorded?
What are some common accrued expenses?
Is rent an accrued expense?
Photo credit: iStock/Meranna

About the Author

Lauren Ward

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
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