Accrued expenses: Definition, examples, and why they’re important

Proper accounting is crucial for business owners to maintain accurate records of their transactions. To that end, accrued expenses are key to understanding your business’s financial health and keeping your books accurate.

In this article, we'll break down what accrued expenses are, offer some examples, and explain how they differ from other types of expenses. We'll also outline best practices for recording and managing accrued expenses.

What are accrued expenses?

An accrued expense, also known as an accrued liability, is an expense your business has incurred but not yet paid. If your business uses accrual basis accounting, you would recognize these expenses in your accounting records even though the transactions aren’t complete because it gives you a more accurate picture of your company’s finances.

Employee salaries are a classic example of an accrued expense. Let’s say you pay your employees twice a month for their previous 2 weeks of work, which means these workers have rendered services before receiving payment. Prior to payday, you would record those paycheck amounts in your records as accrued expenses since there hasn’t been any cash outflow yet.

Examples of accrued expenses

Any expense you know you’ll incur but expect to pay later qualifies as an accrued expense. Here are some common examples of accrued expenses:

• Wages, salaries, and bonuses
• Rent payments
• Utility expenses
• Accumulated interest on loans or lines of credit
• Monthly insurance premiums
• Estimated taxes for a given period
• Employee expenses that haven’t yet been reimbursed
• Unused sick or vacation time for employees
• Anything you’ve purchased but haven’t received an invoice for, including materials, office supplies, equipment, services, or anything else

Cash basis accounting vs. accrual accounting

Whether you recognize accrued expenses on your income statement depends on the accounting method your business uses. The two major accounting methods are cash basis accounting and accrual basis accounting.

The main difference between cash and accrual accounting lies in when you record expenses and revenues in your books:

• In cash basis accounting, you report revenues on your income statement only after you’ve received payment from your client or customer. Similarly, you only record expenses when you pay them out, regardless of when you purchased the goods or services. For that reason, accrued expenses don’t exist in cash accounting.
• In accrual basis accounting, you report revenues as soon as you’ve delivered goods or services with the expectation that payment will follow. The same goes for your expenses: You record expenses as soon as you’ve made a purchase, irrespective of whether you’ve paid for them. This practice forms the basis of accrued expenses.

Each of these accounting methods has their pros and cons, and it’s especially important to note that you shouldn’t switch back and forth between cash and accrual accounting, particularly within the same accounting period. While you can switch from one method to the other, it’s a major undertaking that requires a lot of work and careful planning.

Accrued expenses vs. accounts payable vs. prepaid expenses

Accounts payable are similar to accrued expenses in that both are liabilities. Accrued expenses represent money your company owes for goods or services you’ve already received but not yet been billed for. Accounts payable, on the other hand, refers to money your business owes for goods or services for which you’ve already received an invoice.

In contrast, prepaid expenses might be considered the opposite of accrued expenses. As the name suggests, they're expenses you’ve paid in advance for goods or services that'll be provided at some point in the future. So, your company will eventually benefit from these expenditures—like utilities, insurance, or rent paid in advance.

Here’s a quick table to compare these three terms at a glance:

Why accrued expenses are important in accounting

Accrued expenses are an important part of your company's financial records for many reasons.

First, accounting for accrued expenses provides a more accurate picture of your company's financial situation by accounting for all assets and liabilities at any time. This helps you make more strategic decisions about how to grow your company sustainably. It can also equip you to budget for later expenses, manage cash flow, and forecast future profits.

Second, your accrued expenses might also have tax implications since they could be deductible in the present tax year. Recording accrued expenses is also useful in the event of an audit or financing move that subjects your accounting books to greater scrutiny.

How to record accrued expenses in a journal entry

Accrued expenses are recorded using the journal entry accounting method, so the costs are recognized in your financial statements in the reporting period when they’re incurred rather than when they're paid.

To create a journal entry, identify the expense, determine the specific amount, and then document it by debiting your expense account with that amount and crediting the same to the relevant liabilities account.

For example, if your company’s $2,000 electricity bill is not yet due, you would debit $2,000 to your expense account for utilities and credit $2,000 to your liabilities account for utilities:

Do accrued expenses go on the income statement?

Accrued expenses go on the expenses section of an income statement and the liabilities portion of your company’s balance sheet. Basically, recording a journal entry involves debiting an expense account and crediting a liability account. Once that accrued expense is paid, you reverse the entry by debiting the accrued liability account and crediting the asset account.

How to manage accrued expenses

To get the benefits of the accrual method of accounting, you need a process for properly managing accrued expenses. Below is a step-by-step guide to the accrued expense management process:

1. Identify your accrued expenses

Go through your company’s expenses to identify the ones your business has incurred but not yet paid for. Look out for things like rent, utilities, salaries, and miscellaneous fees that might reflect goods or services you’ve already received but not yet been billed for.

2. Document the expenses

The next step is to document these accrued expenses in your accounting system using the journal entry system outlined above. Check that you have the accurate amounts to debit and credit the relevant accounts. Try to make these records as early in the process as possible to ensure accuracy, and keep your documentation organized to prepare for any potential audits.

3. Implement an accrual accounting system

Expense management software can help you identify and track accrued expenses in real time. You can set up entries for known recurring expenses and use the technology to ensure they’re accurate and up to date. The best platforms allow for seamless budgeting and payment planning, with regular financial reports that accurately reflect a company’s current financial picture.

Another benefit of this system is that it saves the time and resources it takes to manually update spreadsheets and otherwise stay on top of these transactions. Using software reduces opportunities for human error and takes the guesswork out of managing finances. It also prepares you for any potential audits.

4. Conduct reviews to ensure compliance

To keep your accrual accounting system running smoothly and correctly, conduct periodic check-ins to confirm the accuracy of your entries and make any necessary adjustments. Make sure your system is operating in compliance with the applicable industry standards.

5. Schedule and record payments

Don’t forget to schedule your actual payments for the proper time. Document these payments and make sure the amounts correspond to the accrued expense records—or make the proper adjustments to update your company’s financial picture.

Streamline your expense management with Ramp

Ramp’s all-in-one expense management platform is the ideal tool for business owners looking to make their accounting processes more efficient. Our modern financial software saves time and reduces errors with features like:

• Automated expense reporting and approvals, including OCR-powered receipt matching
• Extensive integrations with the apps you already use in your tech stack, including accounting software like NetSuite, QuickBooks, and Sage Intacct
• AP automation features that ensure every invoice is recorded, approved, and paid without any manual data entry

Want to learn more about how Ramp saves businesses an average of 5% a year? Watch our demo video.