Accrued expenses

3 key takeaways

• Accrued expenses represent costs incurred but not yet paid.
• They are recorded as liabilities on the balance sheet.
• Recording accrued expenses ensures that financial statements reflect expenses in the period they are incurred.

What are accrued expenses?

Accrued expenses are liabilities that reflect costs a company has incurred but has not yet paid or officially recorded in its financial records by the end of an accounting period. These expenses are recognized when they are incurred, regardless of when the payment is made, ensuring that financial statements accurately depict the company’s financial condition.

Importance of accrued expenses

Accrued expenses are essential for accurate financial reporting. They ensure that expenses are matched with the revenue they generate, adhering to the matching principle of accounting. This practice helps provide a realistic picture of a company’s profitability and financial health, making it easier for management and stakeholders to make informed decisions.

How accrued expenses work

1. Incur the expense: A company incurs an expense during an accounting period but does not immediately pay for it.
2. Record the accrual: The company records the expense as an accrued expense in its financial records, increasing both an expense account and a liability account.
3. Payment: When the company eventually pays the expense, it reduces the liability account and the cash account.

Examples of accrued expenses

• Salaries: Employees work during the last days of the month, but their salaries are paid in the following month. The company records the salaries as an accrued expense in the current month.
• Utilities: A company uses electricity throughout the month but receives and pays the bill in the following month. The utility expense is accrued at the end of the current month.
• Interest: A company incurs interest on a loan during the month but pays the interest at the end of the quarter. The interest expense is accrued monthly.

Real-world application

Consider a company that has employees working in the last week of December, but their paychecks are issued in January. To accurately reflect December’s expenses, the company accrues the wages for those days in December. This ensures the financial statements for December show all incurred expenses, even those not yet paid.

Understanding accrued expenses is crucial for maintaining accurate financial records and ensuring compliance with accounting principles. By recognizing these expenses when they are incurred, companies can provide a true and fair view of their financial performance. For further insights, you might explore accrual accounting, the matching principle, and financial statement preparation.