Short Storyline
Imagine your company receives an electricity bill in December, but you plan to pay it in January. Should you ignore this expense in December’s books? 🤔
If you do, your profits will look higher than they actually are, and your financial statements won’t reflect the true picture. This is why we use accrued expenses—to recognize costs when they are incurred, even if the cash payment happens later.
Let’s break it down step by step!
What is an Accrued Expense?
An accrued expense is a cost that a company has incurred but has not yet paid by the end of the accounting period. It is recorded under current liabilities because the business owes money for services or goods already received.
Examples of Accrued Expenses
- Salaries payable – Employees worked in December but are paid in January.
- Utility bills – Electricity used in December, bill paid in January.
- Interest payable – A loan accrues interest daily, but payment happens quarterly.
- Taxes payable – Taxes owed for the year but paid later.
Key Features of Accrued Expenses
✅ Expense incurred before payment is made
✅ Recorded as a liability on the balance sheet
✅ Follows the accrual accounting principle
Comparison: Accrued Expense vs. Prepaid Expense vs. Deferred Expense
| Feature | Accrued Expense | Prepaid Expense | Deferred Expense |
| When is it recorded? | After expense is incurred but before payment | Before expense is incurred (paid in advance) | When payment is received before delivering goods/services |
| Account Type | Liability (Accounts Payable) | Asset (Prepaid Asset) | Liability (Unearned Revenue) |
| Example | Salary payable at month-end | Rent paid for next 6 months | Advance payment for annual software subscription |
What is the Journal Entry for Accrued Expenses?
When Expense is Incurred But Not Yet Paid
A company received an electricity bill of ₹8,000 in December, but it will pay in January.
Journal Entry (December – Recognizing Expense)
Debit: Electricity Expense ₹8,000 (Recognizing cost incurred) Credit: Accrued Expense Payable ₹8,000 (Liability created) Narration: “Recorded ₹8,000 as electricity expense for December, to be paid in January.”
When the Expense is Paid in the Next Period
Once the company pays the bill in January, the liability is cleared.
Journal Entry (January – Payment Made)
Debit: Accrued Expense Payable ₹8,000 (Clearing liability) Credit: Cash/Bank ₹8,000 (Cash outflow) Narration: “Paid ₹8,000 for electricity bill incurred in December.”
Real-Life Example
A company hires a contractor for maintenance work in December but will pay ₹50,000 in January.
- December (Expense Recognized)
Debit: Maintenance Expense ₹50,000
Credit: Accrued Liability ₹50,000 - January (Expense Paid)
Debit: Accrued Liability ₹50,000
Credit: Cash/Bank ₹50,000 This ensures that December’s profit reflects the expense even though the cash goes out in January.
Why is Accrued Expense Important?
✅ Prevents understating expenses in financial statements.
✅ Ensures accurate profit calculation for each period.
✅ Helps in cash flow planning for future payments.
Placement in Financial Statements
Balance Sheet (Before Payment is Made)
Accrued expenses appear under Current Liabilities as short-term obligations.
Balance Sheet -------------------------------------- Credit (Cr) | Debit (Dr) -------------------------------------- Liabilities | - Current Liabilities | Accrued Expenses ₹8,000 | -------------------------------------- Profit & Loss Statement (When Expense is Recognized)
Once recorded, the expense affects the Profit & Loss (P&L) Statement under Operating Expenses.
Profit & Loss Statement -------------------------------------- Credit (Cr) | Debit (Dr) -------------------------------------- Operating Expenses | - Electricity Expense ₹8,000 | -------------------------------------- How to Calculate Accrued Expenses?
Formula:
Accrued Expense = Total Expense Incurred - Payment Made Example Calculation:
- Total Salary for December = ₹1,00,000
- Paid in December = ₹20,000
- Accrued Salary Payable = ₹1,00,000 – ₹20,000 = ₹80,000
Life Cycle of Accrued Expenses
Steps Overview:
- Expense Incurred – The company receives goods/services but hasn’t paid yet.
- Recognizing Expense – Record under Accrued Expenses (Liability).
- Payment Made – Clear the liability by paying the expense.
- Completion – No more outstanding liabilities.
Detailed Steps & Journal Entries:
1. Expense Incurred But Not Paid
Debit: Expense Account ₹5,000
Credit: Accrued Expense Payable ₹5,000 2. When Cash is Paid
Debit: Accrued Expense Payable ₹5,000
Credit: Cash/Bank ₹5,000 At this point, the Accrued Expense account is cleared.
Real-Life Practices: Reversal vs. Non-Reversal
✅ Reversal Approach: Ensures accrued expenses are reversed at the start of the next period.
❌ Non-Reversal: Can lead to inflated liabilities in financial statements.
Common Mistakes to Avoid
🚫 Forgetting to record expenses in the correct period.
🚫 Misclassifying accrued expenses as prepaid expenses.
🚫 Not reversing accrued liabilities when necessary.
Relevant Accounting Standards (GAAP, IFRS, IAS)
- IFRS 15 – Revenue Recognition
- IAS 37 – Provisions, Contingent Liabilities & Assets
- US GAAP (ASC 450) – Accrued Liabilities
For more details, check GAAP vs. IFRS Differences.
FAQs
1. Accrued Expense: Asset or Liability?
✅ Liability – It represents money owed but not yet paid.
2. Accrued Expenses in Profit & Loss Account?
They appear under Operating Expenses when incurred.
3. Accrued Expenses: Which Type of Account?
✅ Liability Account under Current Liabilities.
4. How Do Accrued Expenses Affect Financial Statements?
- Increase liabilities (Accrued Payables).
- Reduce profits in the correct period.
5. Difference Between Accrued, Prepaid, and Deferred Expenses?
| Feature | Accrued Expense | Prepaid Expense | Deferred Expense |
| Payment | Yet to be paid | Paid in advance | Received in advance |
| Accounting | Liability | Asset | Liability |
Conclusion
Accrued expenses ensure accurate financial reporting by recognizing costs when they occur, not when they are paid. Whether it’s salaries, utilities, or interest, recording accrued expenses properly helps businesses maintain transparent and accurate financial statements.