Costs that have not yet been invoiced and paid by the business but will be in the future. Your business can plan ahead by tracking accrued costs.
Understanding accrued costs can help streamline your business’ operations, maintain a budget that is efficient, and keep records easily accessible for tax deductions.
The Key Takeaways
- Costs incurred by a business but not yet paid are called accrued expenses.
- Estimated expenses may vary from the final invoice.
- Accrued expenses differs from accounts payable because they are recorded before invoices arrive.
Definition and examples of Accrued expenses
Accrued expenses are expenses incurred during one accounting period, but not paid until the following period. Accounts payable are not the same as these because invoices haven’t been received yet or entered into the system.
They are the expenses that your company will have to pay for services or goods it has bought. Even if you haven’t received an invoice, they should be included in your budget as well as other expenses. You can avoid accidentally spending the money that you’ll need to cover these expenses.
The Balance received an email from JC Glancy, ZenBusiness, explaining that these liabilities are known as “accrued liability” because the business is liable for them (i.e. they are obligated …), even though goods or services are not yet delivered or billed).
- Alternate names: Accrued charges, accrued liabilities, accrued costs, accrued expenditures
Subscription services such as domain renewals, email subscription services, marketing and so on, can be an example of frequent accrued expenses. For example, “Subscription services (e.g., domain registration renewals, software subscription services, a data-component=”link” data-ordinal=”1″ data source=”inlineLink” and href=”https://www.thebalancemoney.com/small-business-5181174″>email marketing/a>, etc.) can be a frequent accrued expense,” Daniel Kroytor told The Balance by email.
Some examples of accrued costs include:
- Taxes that aren’t due immediately
- Paying employee wages by the 1st or 2nd of the following month
- Fees for contractors or freelancers that have not yet been invoiced
How Accrued Costs Work
Accrued expenses appear on the balance sheet of your company as current liabilities that must be paid immediately or soon.
Your accounts department will record the liability when your company makes purchases or plans to do so in the internal finance management system. You may have to make estimates until you get a final bill with official expenses. 3
Note:
You may have accrued business income. You may have accrued income if you’ve earned it even though you haven’t received payment for your services or goods.
Glancy provides a useful example to help explain the accrual process.
“On September 1, you signed a contract for a window cleaner who will clean your windows twice a month. You haven’t received an invoice or paid for the service by September 30. You will need to record this expense as a accrual to be able account for it,” Glancy explained.
This expense is accrued until it is paid. 2
Types of Accrued Costs
Here are some common categories to keep in mind for your small-business accounting. Keep in mind these categories when you are doing your small business accounting. 5 7, 8,
| Types of Accrued Expenses | How It Works |
|---|---|
| Salary or Wage | The first week of each month is when employees are paid, and their salary or wages are accrued from the previous month. |
| Interest Payments | If you have a business loan, interest accrues over time up until the payment date. |
| Tax Payments | Taxes are usually paid at the end the year. |
Accrued Expenses and Accounts Payable
Accounts payable and accrued expenses are often confused. Both are important components of small business accounting. Although they may look similar, they do not mean the same thing.
Here are a few key differences that you should be aware of.
| ACCRUED Expenses | PAYABLE ACCOUNTS |
|---|---|
| Before a formal invoice has been received, the should be recorded | Recorded when a bill or invoice has been received |
| Estimates of the cost of goods and services are often made. | The amount of an invoice |
| Accumulate over time | It is not necessary to “accrue”, or increase in time, to be considered accruing. |
The Advantages and Drawbacks of Accrued Costs
Keeping track of accrued expenses has many benefits for business owners. However, there are some disadvantages. Understanding the pros and cons of using an accrual system of accounting is important before you use it.
Pros
- Better planning
- Accurate representation
You can also find out more about Cons
- Margin for errors
- More resources are required
Pros Explained
- Better planning: Tracking expenses can help you better understand your business transactions. You can plan and manage the finances of your small business more accurately. 10
- Accurate Representation: Accrued costs give a realistic view of your company’s assets. This will give a better representation of your company’s performance over the period. 11
Cons explained
- Margin of error: Often, the total amount due as a accrued expense will be estimated and not exact. There is a margin of error in your accounting.
- More resources Setting up a system for recording accrued costs requires hiring, training and supervision of the team. This setup may require the time and resources of your team.
Note:
To remain GAAP compliant, publicly traded companies must use accrual-based reporting to the U.S. Securities and Exchange Commission.
FAQs (Frequently Asked Questions)
How do you account for accrued expenditures?
There are several ways to record the expenses accrued by your business. Others use the accounting software that their business already uses to record these expenses. Some people use apps to track their finances.
What is a journal entry for accrued income?
Journal entry of accrued expenses is the record for accrued income. It’s a record of money owed but not paid for a period.
How can you reduce your accrued costs?
You can reduce your accrued costs by paying down some of them. You will first need to debit your accrual account. You will then credit your expense account for the payment you made.
