Tracking and managing accrued expenses means accounting for expenses within your business as they happen, not further down the track when an invoice is received or payment becomes due. This process gives you a clearer picture of your business's financial health in real time and is the key to accurate and informative financial statements.
This guide covers what types of expenses get accrued, how to track and manage them, and how they fit in with accrual-based accounting methods.
What is an accrued expense?
Accrued expenses (also known as accrued liabilities) are any expenses you record in your accounts before paying them.
Why are expenses accrued?
Accrued expenses typically happen when your business purchases something on credit, and the goods or services are received but not paid for until later. Accruing an expense is unnecessary if the delivery and payment happen in the same month. Other types of accrued expenses include labour costs, insurance premiums, interest payments on loans and taxes owed – current liabilities not yet due for payment.
Examples of accrued expenses
Any expense your business racks up but won't pay within that month is classified as an accrued expense. These expenses often relate to goods or services purchased through invoices – you'll receive the items or services even though you haven't paid your supplier yet. Other common examples of accrued expenses are:
Salary and wages
Commissions and bonuses
Interest payments on loans
Insurance premiums
Tax payments
Warranties on products or services
Utilities
Advantages of accrued expenses
With accrued expenses, you're accounting for expenses as they happen, giving you more clarity and real-time understanding of your cash flow and net revenue.
The main advantages of accrued expenses are:
Accurate financial statements
When you record expenses in the period your business incurs them, you can easily match them with any corresponding revenue for a transparent view of your business operations. Aligning costs and revenue will keep financial statements consistent, accurate and transparent.
Better understanding of your business's financial health
You'll be able to anticipate upcoming financial obligations and plan and allocate resources accordingly. Overall, you'll have a clearer picture of your cash flow and liabilities, so you can make informed decisions.
Disadvantages of accrued expenses
The downside of accrued expenses is that they take more time and expertise to prepare. There are other disadvantages, too:
Represent liabilities for your company
Accrued expenses are liabilities, as they're yet to be paid. The obligation to settle these in the future can put a strain on your cash flow if you don't have enough to cover the payment later.
Quickly build up over time with interest
When you don't make an immediate payment, expenses can quickly build up. If they go unpaid, you may be subject to interest, which can quickly compound the money owed.
What is the difference between accrual accounting and cash basis accounting?
The major difference between accrual accounting and cash basis accounting is when you record expenses and revenue.
In accrual accounting, you record revenue and expenses on the books when it is incurred. Cash basis accounting is the opposite of accrual accounting – you record payments to or from your business in the same period you receive or make them.
While cash basis accounting is a more straightforward way to record expenses and revenue, the method isn't suitable for all businesses, mainly if you sell products or services on credit. It's also hard to see a complete picture of your business's financial health because it only provides a snapshot of your income and expenses at a particular time.
Accrual accounting = Revenue and expenses recorded immediately
Cash basis accounting = Revenue and expenses recorded when money leaves or enters your account
Key differences between accrued expenses and accounts payable
Accrued expenses and accounts payable are both types of liabilities your business may incur. However, there are some key differences between the two.
Accrued expenses are any expenses you've incurred but are yet to pay. They reflect financial obligations, even if there's no invoice (or the invoice is yet to be received).
Accounts payable are amounts owed for goods or services already received and invoiced, with payment due in the near future.
Other key differences relate to where the liabilities sit on your balance sheet, and how they occur. For example:
Accrued expenses
When is it initiated? When an expense is incurred
Where is it recorded on the balance sheet? As a current liability
When does in occur? Regularly or recurring
Accounts payable
When is it initiated? When an invoice is received
Where is it recorded on the balance sheet? As accounts payable
When does it occur? With any purchase on credit
Accrued expenses FAQs
Are accrued expenses credit or debit?
Accrued expenses require double-entry accounting. You record two journal entries – one that's a debit to your expense account and a corresponding credit made to your liability account. When you settle the bill, the accrued liability is reversed (by debiting it), and your cash or bank account is credited.
What are accrued expenses on a balance sheet?
Accrued expenses fall under current liabilities on the balance sheet as they're outstanding payment obligations.
What is the journal entry for accrued expenses?
The journal entry for accrued expenses typically involves debiting an expense account and crediting a liability account.
What is the difference between accrued expenses and prepaid expenses?
When you prepay expenses, you pay the invoice before receiving goods or services. Accrued expenses are the opposite – you receive the goods or services before you pay.
Track, manage and be future-ready
By tracking accrued expenses, you'll have a closer handle on your business health in the moment, more realistic insight into income and expenses and better information to plan for the future. With MYOB's help, switching from spreadsheets to accounting software couldn't be easier. Get started today!
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