During everyday operations, you buy goods and services for your business. Some of these items are likely purchased on credit. To organize expenses and keep your small business cash flow on track, you might need to record accrued liabilities in your accounting books.
You’re a small business owner, not an accountant. If the phrase “accrued liability” is making you think that sounds complicated, don’t panic. It’s actually pretty simple.
What are accrued liabilities?
An accrued liability occurs when you gain a debt, or incur an expense that you have not paid. For example, you receive a good now and pay for it later. Though you don’t exchange cash, you’re obligated to pay the accrued liability in the future. Accrued liability and accrued expense can be used interchangeably.
How do accrued liabilities work?
Usually, accrued liabilities occur in one period, and you pay the expense in the next period. You enter an accrued liability into your books at the end of an accounting period. In the next period, you reverse the accrued liabilities journal entry after paying the debt. This shows the expense paid instead of a debt owed.
An accrued liability is also a debt you incur in a period but do not receive an invoice for in the same period.
Examples of accrued liabilities
You can gain accrued liabilities in a number of ways. Here are some common accrued liabilities examples:
- Accrued interest: You owe interest on an outstanding loan and haven’t been billed by the end of the accounting period.
- Accrued payroll: Taxes on employee wages are due in the next period.
- Accrued services: You receive a service and are billed at a later date.
- Accrued wages: Your employees earn wages but are not paid until the next period.
- Accrued utilities: You used utilities for your business but have not received a bill.
Recording accrued liabilities is a way to anticipate expenses far in advance. You recognize expenses earlier than you are billed. That way, you can map out money you owe accurately.
Get the latest accounting training, tips, and news sent directly to your inbox.
Accrued liabilities and accrual accounting
Accrued expenses only exist in accrual accounting. With the accrual method, you record expenses as they are incurred, not when you exchange cash. The cash-basis method of accounting does not recognize accrued liabilities.
Accrual accounting is built on a timing and matching principle. You make an entry when you incur an expense. At that time, you owe a debt, so the entry is a liability. When you pay the amount due, you reverse the original entry. Then, the entry is shown as an expense paid.
The accrual method gives you an accurate picture of your business’s financial health. But, it can be hard to see the amount of cash you have on hand. Keep that in mind as you record accruals.
Want to find out if the accrual method of accounting is right for your small business? Download our free whitepaper.
How to record accrued expenses in your books
To record accrued expenses, use debit and credit journal entries. In accrual accounting, you must use a double-entry bookkeeping system. This method requires you to make two opposite but equal entries for each transaction.
Entries are debits and credits. Some accounts are increased by debits and decreased by credits. Other accounts are increased by credits and decreased by debits.
To make accrued expense entries, you need to know:
- Liabilities are increased by credits and decreased by debits
- Expenses are increased by debits and decreased by credits
- Assets (cash) are increased by debits and decreased by credits
Remember, accrued liabilities are reversing entries. They are temporary entries used to adjust your books between accounting periods. So, you will make your initial journal entry for accrued expenses. Then, you will flip the original record with another entry when you pay the amount due.
Entering an accrued expense looks like this:
Step 1: You incur the expense
You incur an expense at the end of the accounting period. You owe a debt but have not yet been billed. You need to make an accrued liability entry in your books.
Usually, an accrued expense journal entry is a debit to an expense account. The debit entry increases your expenses.
You also apply a credit to an accrued liabilities account. The credit increases your liabilities.
|Accrued Liability Account||X|
Step 2: You pay the expense
At the beginning of the next accounting period, you pay the expense. You need to reverse the original entry in your books.
To reverse the transaction, debit the accrued liability account. The debit will decrease your liabilities. When you pay a debt, you have fewer liabilities.
You also credit an asset account. In this case, you credit the cash account because you paid the expense with cash. A credit decreases the amount of cash you have.
|Accrued Liability Account||X|
When the original entry is reversed (showing you paid the expense), it’s removed from the balance sheet. This decreases liabilities. Your income statement also shows a decrease in cash.
If you don’t adjust entries after paying expenses, you will have some issues in your books. Here are a few things that will likely happen:
- Liabilities will be understated on the balance sheet
- Expenses will be understated on the income statement
- Net income will be overstated
Bottom line: Your financial reports will make it look like you have more money than you do. Make sure you keep your entries up-to-date each time you pay a liability.
Accrued expenses vs. accounts payable
If by now, you’re thinking accrued expenses sound a whole lot like accounts payable, you’re right. Accrued expenses and accounts payable are similar, but not quite the same.
What are accrued expenses and accounts payable?
Both accrued expenses and accounts payable are current liabilities, meaning they are short-term debts to be paid within a year. But, the nature of the entries differ.
Accounts payable includes amounts you need to pay for items or services bought on credit. These debts are usually owed to suppliers and vendors. You receive an invoice and owe the supplier money. The entry is an accounts payable.
Accrued liabilities recognize any unrecorded expenses incurred but not billed. Accrued liabilities occur from regular, periodic expenses.
When are accrued expenses and accounts payable recorded?
Accounts payable is recorded based on invoices during the normal course of business. You recognize accounts payable every day as you receive bills.
Accrued liabilities are usually recorded at the end of an accounting period. You recognize them before receiving a bill.
Why are accrued expenses and accounts payable recorded?
Accounts payable entries are made to track unpaid invoices. Use accounts payable entries to record bills your business needs to pay.
Accrued liabilities show goods and services that were delivered but not billed. For example, you use utilities. The utility company doesn’t invoice you until after the period. To close your books, you must make an accrued expense journal entry. Accrued expenses can reveal how debts affect the business bottom line before receiving bills.
Need a simple way to record your expenses and liabilities? Patriot’s online accounting software is easy-to-use and made for the non-accountant. We offer free, U.S.-based support. Try it for free today.