Accrued Expense

Definition

Accrued expenses, also known as accrued liabilities, represent costs that have been incurred but not yet paid. These expenses are recorded in a company’s financial statements during the period they are incurred, regardless of when the actual payment takes place. This is in line with the accrual accounting principle, which matches revenues and expenses to the periods in which they are actually incurred, rather than when the cash transactions occur.

Examples

Wages: A company pays its employees every two weeks. One accounting period ends in the middle of a pay cycle. The wages earned by employees up to the end of the accounting period are recorded as an accrued expense.
Utilities: A utility bill for electricity used in December is received and paid in January. The cost of electricity used in December should be recorded as an accrued expense in December.
Interest: If a company has a loan and incurs interest monthly but pays the interest quarterly, the incurred but unpaid interest expense for the first two months of the quarter is an accrued expense.

Frequently Asked Questions

What is the difference between an accrued expense and a prepaid expense?

An accrued expense is an expense that has been incurred but not yet paid. A prepaid expense, on the other hand, is a payment made in advance for goods or services to be received in the future.

How are accrued expenses recorded in the financial statements?

Accrued expenses are recorded as liabilities on the balance sheet and as expenses on the income statement in the period they are incurred.

Why are accrued expenses important in accrual accounting?

Accrued expenses ensure that all incurred expenses are recorded in the period they relate to, providing a more accurate picture of a company’s financial situation and profitability.

Can accrued expenses affect cash flow?

While accrued expenses do not affect cash flow immediately (since the payment has not yet been made), they represent future cash outflows, impacting cash flow management.

How do accrued expenses relate to the matching principle?

Accrued expenses align with the matching principle in accounting, which requires expenses to be recorded in the same period as the revenues they help generate, giving a more accurate reflection of a company’s profitability.

Accrual Accounting

Accrual accounting is an accounting method where revenues and expenses are recorded when they are earned or incurred, regardless of when the cash transaction occurs.

Prepaid Expense

A prepaid expense is money paid for goods or services that will be received or used in the future. It is initially recorded as an asset and is expensed over time as the benefit is received.

Accounts Payable

Accounts payable are amounts a company owes to suppliers for items or services purchased on credit. These are current liabilities showing on the balance sheet.

Accrued Revenue

Accrued revenue is revenue that has been earned but not yet received. These amounts are typically recorded as a receivable on the balance sheet.

Deferred Revenue

Deferred revenue, or unearned revenue, is money received by a company for goods or services yet to be delivered. It is initially recorded as a liability until the service or product is provided.

Online References

Suggested Books for Further Studies

“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
“Financial Accounting Theory” by William Scott
“Principles of Accounting” by Belverd E. Needles, Marian Powers, and Susan V. Crosson

Accounting Basics: “Accrued Expense” Fundamentals Quiz

### What is an accrued expense? - [ ] An expense that has been paid but not incurred. - [x] An expense that has been incurred but not yet paid. - [ ] Payment made for future services. - [ ] An overdraft in company's bank account. > **Explanation:** An accrued expense is an expense that has been incurred but not yet paid, which is recorded as a liability. ### Under which accounting principle must accrued expenses be recorded? - [ ] Cash basis accounting - [x] Accrual accounting - [ ] Tax basis accounting - [ ] Regulatory accounting > **Explanation:** Accrued expenses are recorded under the accrual accounting principle, which records transactions when they occur rather than when cash changes hands. ### Where do accrued expenses appear on the balance sheet? - [ ] As an asset - [ ] Under owner's equity - [x] As a liability - [ ] Under revenue > **Explanation:** Accrued expenses appear as a liability on the balance sheet because they represent obligations to pay in the future. ### What type of balance do accrued expenses typically have? - [ ] Debit balance - [x] Credit balance - [ ] Zero balance - [ ] Negative balance > **Explanation:** Accrued expenses typically have a credit balance as they are liabilities. ### What happens to an accrued expense when it is paid? - [x] It decreases. - [ ] It increases. - [ ] It converts to revenue. - [ ] It stays the same. > **Explanation:** When an accrued expense is paid, it decreases as the liability is settled. ### Which of the following is an example of an accrued expense? - [ ] Prepaid insurance - [ ] Deferred revenue - [x] Wages earned by employees but not paid - [ ] Immediate purchase of office supplies > **Explanation:** Wages earned by employees but not yet paid is an example of an accrued expense. ### How are utilities most likely accounted as at the end of an accounting period? - [ ] Prepaid expense - [ ] Revenue - [x] Accrued expense - [ ] Deferred revenue > **Explanation:** Utilities incurred but not yet paid for by the end of the accounting period are recorded as accrued expenses. ### Why is accurate recording of accrued expenses essential? - [x] To reflect true profitability and liabilities - [ ] To inflate earnings - [ ] To defer tax payments - [ ] All of the above > **Explanation:** Accurate recording of accrued expenses is essential to reflect the true profitability and liabilities of a company. ### If a company’s accrued expenses are incorrectly omitted, what is the impact? - [ ] Overstates assets - [x] Understates liabilities and expenses - [ ] Overstates owner’s equity - [ ] No impact > **Explanation:** Omitting accrued expenses understates both liabilities and expenses, providing an incorrect picture of the company's financial position. ### Which principle ensures expenses are recorded in the period they incur? - [ ] Revenue recognition principle - [ ] Cost principle - [ ] Objectivity principle - [x] Matching principle > **Explanation:** The matching principle ensures that expenses are recorded in the same period as the revenues they help generate, providing an accurate depiction of financial performance.

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