# Accrued Expenses in Accounting: Definition, Examples, Pros & Cons

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## What Are Accrued Expenses?

Accrued expenses, also known as accrued liabilities, are those expenses that a company recognizes on its books when they occur but before they have actually been paid. They are recorded in the accounting period in which they are incurred. Accrual accounting requires more journal entries than simple cash basis accounting but provides a more comprehensive and accurate financial picture. Accrued expenses are an essential part of accrual accounting, and [align with](https://www.investopedia.com/ask/answers/011315/why-does-gaap-require-accrual-basis-rather-cash-accounting.asp) generally accepted accounting principles (GAAP) standards.

### Key Takeaways

*   Accrued Expenses Overview: Accrued expenses, also known as accrued liabilities, are recorded on financial statements when they are incurred, not necessarily when they are paid. This approach provides a more accurate representation of a company's obligations.
*   Financial Statement Accuracy: Utilizing the accrual basis of accounting allows companies to reflect a true financial picture by capturing all incurred expenses within the correct period, thus enhancing the reliability of financial statements for stakeholders.
*   Comparing Accounting Methods: Unlike cash basis accounting, which records transactions when cash actually changes hands, accrual accounting offers a more comprehensive view by recognizing economic events as they occur, regardless of cash flows.
*   Balance of Work and Accuracy: While the accrual method demands extensive record-keeping and effort, resulting in the potential risk of misstatements, it is favored for its ability to adhere to GAAP and fulfill legal financial reporting requirements.
*   Reversing Entries Mechanism: Reversing entries are crucial in the accrual accounting process to accurately update records in the future when the actual transactions are settled, thereby preventing duplicates and ensuring accuracy.

## Delving into Accrued Expenses: Key Insights

Since [accrued expenses](https://www.investopedia.com/ask/answers/031015/what-difference-between-accrued-expense-and-accrued-interest.asp) represent a company’s obligation to make future cash payments, they are shown on a company’s [balance sheet](https://www.investopedia.com/terms/b/balancesheet.asp) as current liabilities. An accrued expense can be an estimate and differ from the supplier’s invoice, which will arrive at a later date. Following the [accrual method of accounting](https://www.investopedia.com/terms/a/accrualaccounting.asp), expenses are recognized when they are incurred, not necessarily when they are paid.

An accrued expense occurs when a company buys supplies but hasn't received the invoice yet. Other accrued expenses are interest on loans, warranties, and taxes, which are incurred but not yet invoiced or paid. Employee commissions, wages, and bonuses are recorded when incurred, even if paid in the next period.  
  

> **Important**
>
> Accruing expenses increases both unpaid bills and liability accounts for a company.

## Comparing Accrual and Cash Basis Accounting: Key Differences

Accrual accounting differs from [cash basis accounting](https://www.investopedia.com/ask/answers/09/accrual-accounting.asp), which records financial events and transactions only when cash is exchanged—often resulting in the overstatement and understatement of income and account balances.  

Though labor-intensive due to journaling, accrual accounting more accurately reflects company transactions. This more complete picture helps users of financial statements to better understand a company’s present financial health and predict its future financial position.  

## Distinguishing Between Accrued and Prepaid Expenses

Accrued expenses are the opposite of [prepaid expenses](https://www.investopedia.com/terms/p/prepaidexpense.asp). Prepaid expenses are payments made in advance for goods and services that are expected to be provided or used in the future. While accrued expenses represent liabilities, prepaid expenses are recognized as assets on the balance sheet. This is because the company is expected to receive future economic benefit from the prepayment.

On the other hand, an accrued expense is an event where a company has acquired an obligation to pay an amount to someone else but has not yet done so. For example, there is a lawsuit that the company is expected to lose, so the company records the expense and a liability for the expected payment, even though it has not been paid yet. Therefore, it is literally the opposite of a prepayment; an accrual is the recognition of something that has already happened in which cash is yet to be settled.  

## Weighing the Pros and Cons of Accrued Expenses

### Advantages

Accrued expenses theoretically make a company’s financial statements more accurate. While the cash method is more simple, accrued expenses strive to include activities that may not have fully been [incurred but will still happen](https://www.investopedia.com/ask/answers/121514/when-are-expenses-and-revenues-counted-accrual-accounting.asp).

Consider an example where a company enters into a contract to incur consulting services. If the company receives an invoice for $5,000, accounting theory states that the company should technically recognize this transaction because it is contractually obligated to pay for the service.

Accrued expenses help companies plan and lead to consistent financial reports by including recurring transactions. In addition, accrued expenses may be a financial reporting requirement depending on the company and its U.S. [Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp) filing requirements.

### Disadvantages

Accruing expenses makes accounting more time-consuming and demanding for staff. There is a greater chance of misstatements, especially if auto-reversing journal entries are not used. In addition, a company runs the risk of accidentally accruing an expense that they may have already paid.

The accrual method blurs [cash flow](https://www.investopedia.com/terms/c/cashflow.asp) by including non-cash transactions that haven't affected bank accounts and are not shown in bank statements.  

### Accrued Expenses

Pros

*   Potentially makes financial statements more aligned to actual business operations
    
*   Often makes month-over-month financial statements more consistent
    
*   May yield more useful information for management to make decisions/plans
    
*   Adheres to external financial reporting requirements
    

Cons

*   Often requires more time and resources to prepare compared to the cash method of accounting
    
*   Usually results in greater risk of misstatement (accruals not reversing or accidental duplication)
    
*   May complicate some reporting by blurring cash usage and capital needs
    

## Important Considerations in Accrued Expenses

### Understanding Reversing Entries: A Necessary Step in Accrual Accounting

A critical component to accrued expenses is reversing entries, journal entries that back out a transaction in a subsequent period.

Accrued expenses are not meant to be permanent; they are meant to be temporary records that take the place of a true transaction in the short term. Every accrued expense must have a reversing entry; without the reversing entry, a company risks duplicating transactions by recording both the actual invoice when it gets paid as well as the accrued expense.  

> **Tip**
>
> Many accounting software systems auto-generate reversing entries when prompted.

### Navigating Month-End and Year-End Accrued Expenses

Accrued expenses are prevalent during the end of an accounting period. A company often attempts to book as many actual invoices as it can during an accounting period before closing its [accounts payable (AP)](https://www.investopedia.com/terms/a/accountspayable.asp) ledger. Then, supporting accounting staff analyze what transactions/invoices might not have been recorded by the AP team and book accrued expenses.

For external reporting, accrued expenses are crucial for closing month, quarter, or year-end processes. Companies typically book accrued expenses during the close period, not throughout the month.  

## Practical Example: How Accrued Expenses Work

A company pays its employees’ salaries on the first day of the following month for services received in the prior month. So, employees who worked all of November will be paid in December. If, on Dec. 31, the company’s income statement recognizes only the salary payments that have been made, the accrued expenses from the employees’ services for December will be omitted.

Because the company actually incurred 12 months’ worth of salary expenses, an adjusting journal entry is recorded at the end of the accounting period for the last month’s expense. The adjusting entry will be dated Dec. 31 and will have a debit to the salary expenses account on the income statement and a credit to the salaries payable account on the balance sheet.

When the company’s accounting department receives the bill for the total amount of salaries due, the [accounts payable](https://www.investopedia.com/ask/answers/031015/whats-difference-between-accrued-expenses-and-accounts-payable.asp) account is credited. Accounts payable are found in the current liabilities section of the balance sheet and represent a company’s short-term liabilities. After the debt has been paid off, the accounts payable account is debited and the cash account is credited.

## How Are Accrued Expenses Accounted for?

An accrued expense, also known as an accrued liability, is an accounting term that refers to an expense that is [recognized on the books before it is paid](https://www.investopedia.com/ask/answers/030215/whats-difference-between-accrued-expenses-and-provisions.asp). The expense is recorded in the accounting period in which it is incurred. Since accrued expenses represent a company’s obligation to make future cash payments, they are shown on a company’s balance sheet as current liabilities.

## What Are Some Examples of Accrued Expenses?

An example of an accrued expense is when a company purchases supplies from a vendor but has not yet received an invoice for the purchase. Other forms of accrued expenses include interest payments on loans, warranties on products or services received, and taxes—all of which have been incurred or obtained, but for which no invoices have been received nor payments made. Employee commissions, wages, and bonuses are recorded when incurred, even if paid in the next period.

## How Does Accrual Accounting Differ From Cash Basis Accounting?

Accrual accounting measures a company’s performance and position by recognizing economic events regardless of when cash transactions occur, whereas cash accounting only records transactions when payment occurs. Accrual accounting presents a more accurate measure of a company’s transactions and events for each period. Cash basis accounting often results in the overstatement and understatement of income and account balances.

## What Is a Prepaid Expense?

A prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the income statement. Unlike conventional expenses, the business will receive something of value from the prepaid expense over the course of several accounting periods.

## What Is the Journal Entry for Accrued Expenses?

Accrued expenses are recognized by debiting the appropriate expense account and crediting an accrued liability account. A second journal entry must then be prepared in the following period to reverse the entry.

For example, a company wants to accrue a $10,000 utility invoice to have the expense hit in June. The company’s June journal entry will be a debit to Utility Expense and a credit to Accrued Payables. Then, the company theoretically pays the invoice in July at which point they debit the Accrued Payables account to remove the liability (now paid) and credit cash to reflect the cash outflow.  

## The Bottom Line

Accrued expenses are expenses that a company records before payment. They enhance the accuracy of financial statements by aligning expenses with the period in which they are incurred.   
Accrual accounting provides a comprehensive view of a company's financial obligations and performance, despite being more labor-intensive than cash accounting. It offers a more accurate reflection of financial health by recognizing expenses when services are performed, not just when cash transactions occur.

> **Article Sources**
>
> 1.  Princeton University. "[Year-End Accruals](https://finance.princeton.edu/budgeting-financial-management/month-and-year-end-close/year-end-close/year-end-accruals)."