Accrued Liability: an expense a company has incurred but not yet paid or received an invoice for.
Accrued Liability Details
Companies accrue liabilities throughout its operations. One example of an accrued liability is taxes. Companies accumulate taxes overtime as an expense that needs to be paid in the future. However, before the government provides the invoice for the taxes, the company can only estimate the amount of payment that will be due. This estimation is an accrued liability or an unpaid expense that hasn’t yet been billed.
Accountants record accrued liabilities on the financial statement if the company in question adopts the accrual accounting method. Accrual accounting dictates that companies need to report incurred expenses and earned income as the transaction occurs, regardless of whether a cash exchange happens or not. Most companies use accrual accounting to represent better the companies’ actual performance rather than cash accounting. In cash accounting, companies only record transactions when cash flows occur, the opposite of accrual accounting.
Accountants put entries on accrued liabilities accounts during the period where the company incurs these expenses. If the company accumulates liabilities during this month, then the date at which the company needs to pay the debt is maybe next month or even later. Once the debt is settled, the amount of accrued liabilities will be reversed to zero. Often, people refer to accrued liability as accrued expenses.
Example of Accrued Liability
Purchasing goods and services in credit is not uncommon for businesses. This is also true for the XYZ Company who buys office supplies in March. The company opts to purchase the goods in credit and needs to pay 60 days after the supplies are delivered—somewhere around May. Since the company uses accrual accounting to record transactions, the accountant put a debit on the expense account and credit on the accrued liability account.
Fast forward to May, XYZ Company receives the invoice for the supplies and will pay for it soon. The invoiced amount of supplies expense will then get credited on the accounts payable. After payment is made in full, accounts payable is debited, and cash is credited. Also, the accrued liability account is returned to zero.
Other than goods and services purchased in credit, accrued liability can be in the form of anything else. The most common ones are employees’ wages, utility costs, taxes, loan interests, and other short-term liabilities. Although rare, accrued liability may also be long-term liabilities.
Types of Accrued Liability
The two most common types of accrued liability are recurring and non-recurring accrued liabilities.
Recurring accrued liabilities are things such as wages and electricity. These liabilities will always exist as long as the company stays in operation.
Non-recurring accrued liabilities are expenses that businesses will only incur in certain situations. The most straightforward instance is the purchases of goods and services. These spendings will only happen if and when the company needs it.
Accrued Liability vs. Accounts Payable
Accrued liability and accounts payable are pretty similar in that both of them are unpaid expenses. The critical difference is that accounts payable records liabilities that have been billed or invoiced, while accrued liabilities are the ones that haven’t. Since accrued liability is not invoiced, its amount is usually an estimation. Meanwhile, accountants include accounts payable after the unpaid expense is billed, meaning the exact amount is already known.
To get a better perspective, let’s consider the previous example. When the XYZ Company receives its supplies, it hasn’t received the bill for the goods, crediting it to accrued liability. After the company accepts the invoice, it erases the accrued liability account and replaces it with a credit to the accounts payable. After the debt is paid off, the company debits the accounts payable and credits the cash.