Accrued Expense: is an expense that has been incurred or recognized on the books but not yet billed and paid.
Accrued Expense Details
Accountants record accrued expenses on the period during which it is incurred, not when it is paid. Putting it differently, when companies accumulate any unpaid expense during a period, these expenses are recorded in the ledger as accrued expenses. Meanwhile, the payment date itself happens on a later date or during a different period. When accrued expenses are incurred, companies typically won't receive the invoice or bill just yet. In this case, the amount of accrued expense is usually an estimation, not an exact number.
Accrued expenses are the direct result of accrual accounting—which dictates companies need to acknowledge income and expenses as they’re incurred, not when a cash exchange occurs. A simple example of accrued expense is when a company buys office supplies from a supplier but doesn’t yet receive the goods' invoice. In this situation, most companies choose to estimate the amount of accrued expense as they can’t possibly know the exact price for the supplies before the invoice is delivered. Accrued expense, also known as accrued liabilities, is recorded on the balance sheet as current liabilities since payments’ due date is usually within one year.
Accrued expenses are the direct contrast to prepaid expenses. Prepaid expenses are payments for goods or services that are made first before the items are consumed. Accrued expenses are liabilities, while prepaid expenses are recorded as assets on the balance sheet.
Example of Accrued Expense
A typical example of accrued expenses in real life is employees’ wages or commissions. Most companies pay their employees’ current month services at the beginning of the next month.
The ABC Company is one such company, and they follow the guidelines of accrual accounting. The company includes the amount of accrued expense with the following entries on the financial statement for this month: debit on account of salary expense and credit on account of the accrued salary.
Next month, ABC Company will pay the salaries and make some adjustments on the balance sheet. Once the company determines and produces the invoice of the salaries’ exact amount, the account for accounts payable is credited under the current liabilities section of the balance sheet. After the company pays the wages, accounts payable is debited, and asset/cash is credited. Furthermore, the accrued salary account is reversed.
Salary is only one of the most common accrued expenses recorded by companies. Other typical cases of accrued expenses consist of:
- Consumed services and goods that haven’t been billed yet.
- Utilities such as electricity and water for this month will receive an invoice next month.
Accrued Expense vs. Accounts Payable
Accounts payable refers to unpaid expenses that must be settled at a specific time. This may include goods and services purchased on credit. Since the due date of accounts payable is typically close to the date where goods or services are delivered, accounts payable is also a part of current liabilities.
Accrued Expense and Accounts Payable have similarities in that both of them are short-term expenses that haven’t been paid. However, there’s one significant difference between the two: the value of accounts payable comes after companies receive bills or invoices, meaning the exact amount of expense is already determined. Meanwhile, accrued expenses are generally an estimation value before companies receive an invoice.
Pay attention to the previous section's example, and you may notice that we credited the accounts payable with the salaries amount after it is billed. At that point, the company certainly knows how much money it needs to give to its employees. This is different from the month before, where the amount of accrued expense (debited on salary expenses and credited on the accrued salary) is usually an estimation.