When getting familiar with your balance sheet, there are two easy to confuse yet very different liability accounts - accrued expenses and accounts payable. Accounts payable are tracked, invoiced payments to creditors that previously made credit-based sales to your company. On the other hand, accrued expenses are records of money owed to vendors when the invoice has not yet been recorded or received. Knowing when to use these two different categories is vital to having an accurate balance sheet. Read on to learn more about the nuances of these terms.
What are accrued expenses?
Accrued expenses, also known as accrued liabilities, generally include anything where you have received a product or service but have not yet paid for them. This often is because the supplier's invoices have not yet been received but includes other instances like payroll. They fall within the category of current liabilities, as they are often due within a year. These can be looked at as the opposite of a prepaid expense - expenses made prior to receiving services or items. Representing your obligation to pay for some good or service in the future, keeping accurate track of these can help you show a more accurate and future-conscious record.
What are accrued expenses in accounting?
Accrued expenses fall within the accrual method of accounting. Compared to other types of accounting, such as cash basis accounting, it is much more accurate and gives a better reflection of your total financial health. While it can be more work to track transactions this way, overall it is a great method for ensuring your financial statement and income statement displays more accurately, showing your accounts' full story. This method requires some estimation since you will not have received an accurate invoice or total of what you need to pay, but it still helps you better measure your accounts than if you didn't track them until payment.
With all that being said, the cash basis accounting method is actually more popular in some sectors. This type of accounting looks at net income only when you receive invoices or money, not when you receive the good or service. This often is easier to track but can result in very misleading reports if your accrued expenses start adding up.
What is an example of an accrued expense?
Accrued expenses can sound like they apply only occasionally, however it is much more common than you would expect. The most common examples of this are employee wages and salaries, rent, or utilities where you receive their services and pay them at a later set date. Accrued expenses can also occur when you purchase something but have not yet received the service or item invoice. Along with these more common examples, interest expense or interest payable also fall within this category. Some other examples are things like taxes and commissions. As you can see, accrued expenses are so common that not tracking them can mean a huge change in your reports!
What is the difference between accrued expenses and accounts payable?
Accounts payable (also sometimes just called "payables") usually are short-term debt obligations to vendors or companies that must be paid for the services or goods bought through credit. They encompass the total amount of these items bought through credit, and with these entries, the invoices have been recorded. Because an invoice has already been received, these are accurate, measurable numbers. An accounts payable account is considered a current liability.
On the other hand, accrued expenses don't have invoices associated with them yet, meaning they are estimations. Because of this, they are not recorded on a company's general ledger like accounts payable is. These expenses are also estimations unlike accounts payable and are adjusted to be accurate once the invoice is received if necessary. Accrued expenses are also considered current liabilities.
How are accrued expenses recorded?
When incurred, they create an accrued expense account in your balance sheet that is shown as their own line item. These show up as a current liability on your company's balance sheet. Because often you do not have an exact invoice to record from, these entries are often estimates. If there are still unresolved expenses at end of the accounting period, you have to create an adjusting entry. Once you pay off your adjusting journal entry debt, you credit your cash account and debit your accounts payable account. Once you are able to show that you have paid the amount, you can remove it from your balance sheet, which will decrease your liabilities.
Is accrued income an asset?
As we alluded to above, your accrued interest is tracked through your income statements at the end-of-period financial statement. It shows as a current asset on your balance sheet in your accrued receivables account and is adjusted in the future once paid.
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