Accrued expenses are costs you already have incurred but for which you have not yet paid or documented payment. Accrued expenses are part of virtually all business and personal budgets, and may be accounted for in different ways, depending on the accounting system you use.
Accrued expenses aren’t necessarily a problem—in fact, they’re a necessity. All businesses use products and services before they actually pay for them. However, it’s important to understand accrued expenses as a way to manage your bottom line and understand where your business stands financially. Below are examples of accrued expenses and accounting options for managing your accrued expenses.
Definition and Examples of Accrued Expenses
Accrued expenses, such as accounts payable, are costs your business has incurred for goods and services but for which you have not yet been billed. Because the bill (or payment date) has not arrived, no money has yet changed hands.
If you use a cash accounting method, you may not even record accrued expenses because no money has changed hands. If you use an accrual method, however, accrued expenses are recorded at the time the expense is incurred.
It’s key to separate accrued expenses from accounts payable. While both represent money that will be spent, they are not identical. Accounts payable are short-term expenses that must be paid because an invoice has been submitted. Accrued expenses are costs that are known to exist even though no invoice has yet been submitted.
Common examples of accrued expenses are regular costs such as rent, electricity, and wages. Your company gets the benefit of space, heat, and employee labor for up to a month before you receive an invoice or pay for them. If you are using an accrual method of accounting, you’ll record those expenses as you receive the benefits you’ll be paying for. If you’re using a cash method of accounting, however, you won’t record those expenses until cash goes out the door to pay for them.
Another example of accrued expense is a product or service that already has arrived and been used before it’s been invoiced or paid for; for example, a repair is made to your printer but no invoice has yet been sent for the repair work. Of course, you owe the repair shop money regardless of whether the invoice has arrived, so the repair is an accrued expense.
How Accrued Expenses Work
If you’re a large U.S. publicly traded corporation, you’re required to use the accrual accounting method and show your accrued expenses at all times. This requirement is part of the federally mandated Generally Accepted Accounting Principles, known as GAAP, and it’s considered an important way to maintain ethical accounting practices.
If you’re a small private business, however, GAAP doesn’t apply, so you can choose between showing or not showing your accrued expenses in your financial records.
The benefit of showing accrued expenses is that as a business owner, you have a true picture of how much money is actually available as opposed to how much already has been spoken for.
Imagine you run a small business that sells jewelry from a storefront. You have a store manager who is paid $2,000 at the end of each month, a cleaning service that forgets to bill you but charges $200 per month, and a $150 electricity bill coming soon. Your jewelry maker shipped you an order valued at $1,000 but the invoice got lost in the mail. All of these are accrued expenses.
If you use the cash method of accounting, you will have entered none of these expenses into your accounting software. After all, no money has changed hands yet. This keeps things simple, but it also suggests you have an extra $3,350 available—which you might spend without realizing it’s already been spent. If you use the accrual accounting method, you will have accounted for all those expenses before they are paid out.
- Accrued expenses are costs to your business for which you have not yet been invoiced and which you have not yet paid.
- Examples of accrued expenses include monthly costs of rent and utilities, employee wages, and certain products and services if you are using them but have not yet been billed for them.
- Accrued expenses are accounted for more readily in the accrual accounting method than in the cash accounting method.