Accrued expenses or accrued liability is an accounting term used for expenses that business bodies have already incurred but not paid. The concept is similar to buying something with a credit card that will need to be repaid in the future.
It is important to track these expenses and account for them so stakeholders have the right picture of the business’s financial position.
What are Accrued Expenses?
Accrued expenses refer to the expenditure against which a business has already reaped the benefit, but still has to remit payment. Hence these expenses are considered to be a liability for business bodies.
A good example for an accrued expense are utilities – most businesses use gas and electricity throughout the month without paying. Payment for these utilities is done in the next month, meaning that the utility bill is an accrued expense.
Accrued expenses are an estimate which may or may not match what is actually paid. These expenses are not permanent and are considered to be temporary records until they turn into a true financial transaction in a short span.
Examples of Accrued Expenses
- Wage expenses
- Rent expense
- Loan interest
- Government taxes
- Payments to vendors and contractors
- Property rental cost
- Employee salaries and commissions
- Good and services received
- Utilities etc.
Accrued Expenses vs. Prepaid Expenses
Accrued expenses and prepaid expenses are exact opposites. Accrued expenses are the expenses businesses pay for after receiving goods or services, while prepaid expenses are those which have been paid for in advance.
Examples of prepaid expenses are subscriptions, insurance premiums, etc., and examples of accrued examples are raw materials and supplies, loans etc. Accrued expenses are considered as a current liability, while prepaid expenses are considered business current liabilities.
How To Track Accrued Expenses?
Tracking and accounting for accrued expenses when preparing a business’s financial statements so stakeholders can see the true financial position of the business.
There are two ways of accounting: the cash basis and the accrual basis.
Accrual basis accounting needs extensive journaling and is labour-intensive. However, it extends proper representation of all the transactions and events of a firm. As the name suggests, cash basis accounting keeps track of the financial transactions and expenses only when cash is exchanged.
Small businesses and sole proprietors use the cash basis method. On the other hand, large companies use accrual accounting.
In addition, business firms opting for cash basis accounting are taxed when earnings from a sale are deposited in their account. Contradictorily, business firms depending on accrual accounting incur tax liability on sales recorded in a financial year; however, the sales can or cannot be paid for.
How to Manage Accrued Expenses?
It is imperative for business bodies to keep a record of the accrued expenses and they can do either by using accounting software or by maintaining a spreadsheet in journal form.
- Accounting Software: The accounting software allows business entities to open an accrued expense account. It will help them track the amount of money they owe and the payments that are due.
- Spreadsheet: A spreadsheet or journal enables a business to list down all accrued expenditures in one sheet. It helps get a clear overview of the money that business owners owe and the payments they need to initiate.
Advantages of Accounting Accrued Expenses
- Tracking accrued expenses gives a compact idea of a company’s total expenses and makes business operations more aligned.
- Accounting accrued expenses make monthly-based financial statements of a business more accurate, coherent and consistent. As the financial transactions go into the book continuously, there is less chance of any discrepancy, thus making business operations transparent.
- Accrual accounting helps business bodies get a vivid idea of the business cash flow and have knowledge of their liabilities.
- A business body that relies on accrual accounting is considerably more established than other business bodies.
- Accrued expenses make it convenient for business bodies to plan and strategize business actions. These expenses yield consistent financial outcomes. This is possible as business entities can incorporate recurring transactions in financial reports.
The Bottom Line
No company can avoid accrued expenses – it is a normal and regular part of the business. To ensure that the business’s financial position is correctly calculated, all businesses need to ensure that the accrued expenses are correctly tracked and accounted for.
While large businesses can afford expensive accounting software and large teams of accountants to handle their finances, smaller businesses and startups may struggle with this facet of the business.
Fortunately, there are plenty of fintech solutions for startup finance problems. RazorpayX is one such solution, which helps startups supercharge their finances.
- Automate invoice management with Vendor Payments
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- Integrate with accounting software to easily track every expense and income your business makes.
What are the advantages of accrued expense journals?
Maintaining an accrued expenses journal helps business bodies in many ways. It helps in forecasting profit margin, keeping records of the overall spending and enables business owners to negotiate for better payment terms.
What is the difference between accrued expenses and accounts payable?
Accrued expenses refer to the liabilities that businesses have incurred but are yet to pay. The business body is under the obligation to clear payments for such products and services which they have used. On the other hand, account payables refer to the continuous or ongoing business expenses that a business must pay in a given period. This is how business bodies can avoid being defaulters.
What are the shortcomings of recording accrued expenses manually?
The accounting of accrued expenses is extremely time-consuming. There is a higher possibility of misstatements, this usually happens when there is no auto-reversing in journal entries. A business body can also accidentally consider accrued expenses that it has cleared already. In addition, in certain scenarios, accrual accounting processes can increase the risk of fraudulent business transactions.
What are reversing entries?
Reversing entries are an integral component of accrued expenses. As accrued costs are meant to be temporary transaction records, reversing entries must be there. It prevents a business body from duplicating transactions. These entries help in neutralising or cancelling the entries that are already made in the preceding accounting period.