What Are Accrued Expenses? Meaning with Examples & Journal Entries
Accrued expenses are a major concept in accounting that every commerce student must understand clearly. These expenses are vital for preparing accurate final accounts, answering exam questions, and making sense of real-world business transactions. Mastering the concept of accrued expenses helps students score better in school, ace competitive exams, and gain practical business knowledge.
| Type of Accrued Expense | Description | Accounting Treatment |
|---|---|---|
| Unpaid Wages/Salaries | Employee wages earned but not yet paid | Recorded as a liability until paid |
| Utilities Payable | Electricity, water, or gas expenses used but not billed | Accrued and expensed in the current period |
| Interest Payable | Interest on loans incurred but not yet paid | Recognised as accrued liability |
| Rent Payable | Rent due for the period but unpaid at period end | Shown as current liability in balance sheet |
Accrued Expenses: Definition
Accrued expenses refer to costs that are incurred during an accounting period but are yet to be paid or billed. In accrual accounting, such expenses are recognized immediately to present a true financial picture. Common accrued expenses include wages payable, interest payable, and utilities payable.
Understanding Accrued Expenses
Accrued expenses increase both the company’s expenses and its liabilities. While the goods or services have already been consumed, the payment happens in a future period. Accrued expenses ensure business accounts match the actual activities and obligations for a given period.
Accrued Expenses vs. Prepaid Expenses
| Accrued Expenses | Prepaid Expenses |
|---|---|
| Cost incurred, payment pending | Payment made in advance, benefit pending |
| Shown as a current liability | Shown as a current asset |
| Examples: unpaid wages, unpaid rent | Examples: prepaid insurance, advance rent |
| Expense increases, liability increases | Asset increases, expense decreases over time |
Common Examples of Accrued Expenses
- Unpaid salaries or wages at month-end
- Electricity bill used in March but paid in April
- Interest on bank loan not yet paid
- Unpaid rent for the current month
Accrued Expenses Journal Entry & Accounting Treatment
To record accrued expenses, the relevant expense account is debited, while an accrued liability account is credited. When the payment is actually made, the accrued liability is debited and cash or bank is credited. Reversal entries are used to avoid double counting in the next period.
Example of Accrued Expenses Journal Entry
Suppose ₹5,000 salary is unpaid at year-end:
- At year-end (accrue): Salary Expense A/c...........Dr ₹5,000
To Salary Payable A/c.............................₹5,000 - Next month (payment): Salary Payable A/c.........Dr ₹5,000
To Cash/Bank A/c..................................₹5,000
For detailed journal entry practice, see Accrued Expenses Journal Entry.
Accrued Expenses in Financial Statements
Accrued expenses appear in the balance sheet under current liabilities, typically as "Accrued Expenses" or "Outstanding Expenses." On the income statement, the expense is recognized in the period it is incurred, ensuring profitability is not overstated or understated.
To learn more about liabilities, visit Current Liabilities.
Accrued Expenses under Accrual vs. Cash Accounting
Under accrual accounting, expenses are recorded when incurred, not when paid. Cash accounting only recognizes expenses when cash is paid. Accrual accounting gives a fuller financial picture and meets accounting standards like GAAP and Indian Accounting Standards.
To understand why this is important for accurate records across periods, see Accounting Period Concept.
Why Are Accrued Expenses Important?
Accrued expenses help students understand adjustments in financial statements, which are often tested in final accounts and professional courses. Accurate recording is also essential for business management and statutory compliance.
Accrued Expenses: Real-World Application
Businesses, whether small enterprises or large corporations, regularly use accrued expenses for preparing monthly, quarterly, and annual statements. If accrued expenses are missed, profits may be overstated, leading to wrong managerial decisions or audit issues. Learn more about practical applications in Ledger Accounts and Income and Expenditure Account.
Accrued Expenses: Summary
In summary, accrued expenses capture costs incurred but unpaid at period end, ensuring accurate profit calculation and liability reporting. At Vedantu, we make learning about accrued expenses and their accounting simple, practical, and exam-ready. This concept is key for mastering financial reporting in exams and real business situations.
FAQs on Accrued Expenses: Meaning, Examples, and Accounting Treatment
1. What are accrued expenses, with a simple example?
Accrued expenses are costs that a business has incurred during an accounting period but has not yet paid for by the end of that period. They represent a company's obligation to pay for goods or services that have already been received. For example, if a company's employees work in March but are paid in April, the salary for March is an accrued expense at the end of the March accounting period.
2. What is the journal entry for recording accrued expenses?
To record an accrued expense, you make an adjusting entry at the end of the accounting period. The entry involves debiting the relevant expense account and crediting a corresponding liability account. For instance, to record ₹10,000 of unpaid salaries, the journal entry would be:
Salaries Account Dr. 10,000
To Accrued Salaries Account Cr. 10,000
This entry increases the company's expenses and its current liabilities.
3. What is the main difference between accrued expenses and prepaid expenses?
The key difference lies in the timing of payment versus consumption.
- Accrued Expenses are expenses for services already received but not yet paid for. They are recorded as a current liability. Example: Using electricity in December and paying the bill in January.
- Prepaid Expenses are expenses paid in advance for services to be received in the future. They are recorded as a current asset. Example: Paying annual insurance premium in January.
4. Why are accrued expenses classified as a current liability on the Balance Sheet?
Accrued expenses are classified as a current liability because they represent a present financial obligation for the company arising from past events (consuming goods or services). The settlement of this obligation is expected to result in an outflow of cash within the next accounting period, typically within one year. This correctly reflects that the business owes money to an external party.
5. What is the impact on a company's financial statements if accrued expenses are not recorded?
Failing to record accrued expenses leads to a distorted and inaccurate view of a company's financial health. The primary impacts are:
- Income Statement: Expenses are understated, which in turn leads to an overstatement of net profit.
- Balance Sheet: Liabilities are understated because the company's obligations are not fully reported. This falsely portrays the company as having fewer debts than it actually does.
6. How does the accrual concept of accounting relate to accrued expenses?
The recording of accrued expenses is a direct application of the accrual basis of accounting, specifically the matching principle. This principle states that expenses should be recognised in the same accounting period as the revenues they helped to generate, regardless of when cash is actually paid. Accrued expenses ensure that costs are 'matched' to the correct period, providing a true and fair view of profitability for that period.
7. What is the difference between an 'incurred' expense and an 'accrued' expense?
An 'incurred' expense is any cost that a business has sustained or become liable for, whether paid or unpaid. 'Accrued' expense is a more specific term. It refers to a subset of incurred expenses—specifically, those that have been incurred but not yet paid at the end of an accounting period. Therefore, all accrued expenses are incurred, but not all incurred expenses are accrued (for example, an expense paid immediately in cash is incurred but not accrued).
8. What are some common real-world examples of accrued expenses for a business?
Businesses regularly deal with various types of accrued expenses to ensure accurate financial reporting. Common examples include:
- Wages and Salaries Payable: Salaries earned by employees in one month but paid in the next.
- Interest Payable: Interest on a loan that has accumulated over a period but is not yet due for payment.
- Utilities Payable: Cost of electricity, water, or gas consumed in a period for which the bill has not yet been received.
- Rent Payable: Rent for the current month that is due to be paid in the following month.
