One of the trickiest parts of running your own business is understanding the mountain of financial jargon that comes with managing your own finances.
To try and make things a little easier for business owners, this guide will explain what is meant by accrued expenses, how they’re different to similar terms like accounts payable, when to record them in your balance sheet, and how to manage your finances with accounting software.
Specifically, we’ll be covering:
- What are accrued expenses?
- Accrual accounting vs cash accounting: what’s the difference?
- Examples of accrued expenses.
- Recording accrued expenses.
- Accrued expenses vs accounts payable: what’s the difference?
What are Accrued Expenses?
“Accrued expenses” is an accounting term used to describe a cost that you will need to pay in the future, but haven’t been officially charged for yet. It’s usually for subscription based costs, interest payments, or services that haven’t been invoiced yet.
Even though you’ve not been charged, it’s important to keep a record of the expense for your financial records. The amount can be recorded in the balance sheet as an accrued expense.
Because accrued expenses are recorded before they’re paid, the company is liable to pay the cash amount in the future, so they’re sometimes called accrued liabilities.
Accrued expenses are useful because they show a more accurate picture of a company’s finances by accounting for liabilities. That said, the recorded figures are only ever estimates, so they’re rarely 100% accurate.
It’s worth noting that this only applies to companies and businesses that use the accrual method of accounting, rather than the cash method.
Accrual method vs cash method: What’s the difference?
There are two types of accounting, the accrual method and the cash method.
As we mentioned above, the accrual method will account for expenses that haven’t yet been charged, meaning there’s no actual money there but the amount is still recorded in the balance sheet.
Alternatively, the cash method of accounting only records income and expenses when actual cash payments are given or received. On the whole, it’s a much simpler method for financial management, but it won’t always reflect the true financial situation of a company.
The main difference is the time you record revenue and expenses. In the cash method, you only record expenses when the payment is made. With the accrual method, expenses and payments are recorded in the financial period that the payment or expense invoiced.
While the cash method is more accurate in terms of actual cash value, the accrual method gives a more accurate picture of your company’s finances, so you’re not caught out by unexpected costs.
Examples of Accrued Expenses
Accrued expenses are generally split into two categories, recurring costs and costs that you’re expecting to pay in the future. Some common examples include:
- Interest on loans.
- Goods or services, where you’ve not received an invoice yet.
- Taxes incurred, for example, if you can expect to breach the VAT trading threshold.
- Employee wages.
If you run your own limited company, it’s worth knowing that the accrual method is the most common method of accounting, as it’s the most accepted method among other companies and organisations.
Recording an Accrued Expense
Again, because the expenses are recorded before any cash payments, the records will be an estimate. But how does this work in practice?
Usually, an accrued expense journal entry is a debit to an Expense account. The debit entry increases your expenses.
You also apply a credit to an Accrued Liabilities account. The credit increases your liabilities.
For example, it might be the case that your company receives a delivery of office stock near the end of the month (June, for example), but you don’t receive an invoice for the stock (£100) until the next month (July)..
Using the accrual method of the accounting, the expense (£100) needs to be recorded in the month that the stock was received (June).
To properly record this, record a debit payment of £100 into June’s expense account, increasing your expenses.
At the same time, record a £100 credit in your liability account, increasing your liabilities.
When June’s accounting period begins, and you receive an invoice from your office stock supplier, you simply pay the expense and reverse the original entries in your books.
Record a £100 debit in your liability account, decreasing your liabilities.
Then, record a £100 credit in your expense account, decreasing the amount of cash you have.
If you’ve done everything right, your books should show a decrease in both liabilities and cash.
Accrued expenses vs accounts payable: What’s the difference?
It’s easy to confuse accrued expenses and accounts payable. They are very similar in a lot of ways, but they work slightly differently.
Both accrued expenses and accounts payable are liabilities (short-term debt that your company owes), but the main difference is about invoicing.
To put it simply:
- Accrued expenses are expenses that you’ve incurred but not yet received an invoice for. You don’t technically owe any money yet, but you know that you will.
- Accounts payable are expenses that you’ve incurred and received an invoice for. You have been billed, so you officially owe money.
The other side of accounts payable is accounts receivable. For more information about accounts receivable, check out our article, “What is accounts receivable? A guide for the self-employed”.
Manage your expenses with a simple app
Financial admin can be stressful and time-consuming when you’re self-employed. That’s why thousands of business owners use the Countingup app.
Countingup is the business current account with built-in accounting software that allows you to manage all your financial data in one place. With features like automatic expense categorisation, invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are.
You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward!
Find out more here.