Accrued liabilities incur due to accrued expenses. Accrued means expenses that have emerged but have not yet been paid for by the business.
Accrued liabilities can take the form of recurring or non-recurring liabilities. Only the accrual accounting method records the accrued liabilities.
Accrued liabilities are different from accounts payable for a business. A business following cash accounting does not record accrued liabilities.
What Are Accrued Liabilities?
An accrued liability occurs when a business incurs an expense but has not yet been billed for it. It means these are liabilities that a business has recorded but will be paid for in the future.
Businesses following the accrual accounting method record accrued liabilities and accrued expenses. While there is no accrued liabilities/expenses record-keeping in the cash accounting method.
Accrued liabilities are often recorded as short-term liabilities on the balance sheet of a company. However, these can be categorized as long-term liabilities as well.
Accrued liabilities or expenses occur when a business receives goods or services but has not paid for them. There are several reasons for incurring accrued expenses by a business. Anyhow, a business must make a payment for goods or services already received.
Accrued expenses or liabilities become an obligation for a business. Even when these transactions are only recorded for accounting purposes, they must be settled at a later date. Unlike accounts payables, the settlement date for these liabilities is often undecided.
As accrual accounting follows the matching principle, accrued liabilities also follow the same pattern. Liabilities are first recorded as and when they incur. It means all expenses are recorded in the same accounting period in which they incur. A reversal entry is recorded later when the expenses are settled with payment.
Accrued Liabilities – Examples
A business can incur several expenses that would be paid at a later date. Businesses following the matching principles must record these expenses immediately.
Some of the commonly used accrued expenses are given below.
A common form of accrued expenses comes with the accrued wages. This happens when employees or contractors have already performed their assigned duties but the wages would be paid at a later date.
Independent contractors and freelancers are common examples of accrued wages.
Accrued Interest and Taxes
Businesses must record their interest and tax liabilities as soon as they incur. However, interest charges can be paid up to a certain deadline. Similarly, taxes can be paid up to a certain date.
Accrued Goods or Services
Businesses can order from their regular suppliers for goods or services. Trade terms allow buyers to pay at a later date. This is a common practice for many businesses to receive goods or services and pay later.
Certain professional services such as outsourced accounting, auditing, and bookkeeping are often paid with delayed terms.
Accrued Operational Expenses
Although uncommon but certain expenses such as electricity or other utilities are consumed before payment. These expenses can also be categorized as accrued expenses.
Types of Accrued Liabilities
Accrued expenses can be of any type and nature depending on the industry and size of a business. However, we can broadly categorize accrued liabilities into two categories.
Recurring/Routine Accrued Liabilities
These are expenses that a business incurs regularly. Operational expenses including utilities are a common example of these recurring expenses.
Businesses with long-term contracts also incur routine accrued liabilities for goods and services received from their contractors.
For example, a business has outsourced its accounting services for 2 years. Its outsourcing partner will send an invoice quarterly. The business can record the invoice as an accrued expense as soon as received. However, the liability can be settled at a later date.
Non-Routine/Infrequent Accrued Liabilities
As the name suggests, these are infrequent expenses of a business. One-off purchases of goods or services availed of can be termed in this category.
As these expenses are unexpected and often incur as a one-time expense, businesses usually delay payments for them.
A customized product such as manufacturing machinery purchased on credit terms is an example of infrequent accrued expense.
Journal Entries for Accrued Liabilities
Accrued liabilities do not involve cash payment spontaneously. The journal entry for accrued liabilities will first be recorded with an expense and later settled with cash.
The first journal entry will be:
The second journal entry is created when the transaction is settled with cash. The transaction can be settled in full or partial amounts.
Accrual accounting provides an accurate picture of a company’s profitability. Without following the matching principles, a company would overstate its profits. Accrual accounting is also in compliance with the US GAAP rules.
Suppose a company ABC wants to outsource its accounting services. It enters into a long-term contract of five years with an outsourcing partner company XYZ.
Both parties agree to make payments quarterly. The quarterly payment for the services rendered is $ 6,000.
ABC records the first entry of accrued expense payable to XYZ on the 1st of September. XYZ invoices ABC for the same on 5th September. The cash settlement for the first invoice takes place on the 10th of September.
The journal entries for these transactions will be recorded as below.
|XYZ Services||1st September||$ 6,000|
|Accrued Liability||$ 6,000|
The second journal entry will be:
|Accrued Liability||10th September||$ 6,000|
The accrued liability settlement can be made in full or partial amount. Suppose, ABC company makes a partial payment of $ 4,000 to XYZ in one month and the remaining amount the following month.
The journal entries will be:
|Accrued Liability||10th September||$ 4,000|
|Accrued Liability||10th October||$ 2,000|
Accrued Liabilities v Accounts Payable
Both types of entries are created when an entity makes a deferred payment for an already received service or product. Accrued liabilities can be short-term or long-term entries. However, accounts payable are only short-term expenses within an accounting period.
Accrued liabilities and payables differ with their billing methods. Accruals can be recorded before they are billed by the seller of a service or product. In our example above, the company receiving accounting services records an accrual liability on the 1st of September as soon as it realizes the expense.
On the other hand, accounts payable are recorded when they are billed. It means the company knows its payment terms and date. Accounts payable are due within the same accounting period, usually, less than a year.
A key distinction of accruals is the absence of binding documents such as a bill note or invoice. Since most of these expenses are predictable and frequent, a company can create a journal entry for recording the expense in the same accounting period.
In that sense, each account payable can be a type of accrual liability. However, it’s not necessary that every accrual expense becomes an account payable.