What Are Accrued Expenses? Definition and Examples

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Accrued expenses are costs a company has incurred during an accounting period but has not yet paid, and often has not yet been billed for, by the time the books for that period close. Under accrual accounting, the company records these costs as expenses in the period the goods or services were used and, at the same time, records a liability for the amount it owes. Accrued expenses are also called accrued liabilities, and on the balance sheet they almost always sit under current liabilities because they are normally settled within a year.

What does it mean to accrue an expense?

To accrue an expense is to record a cost on the books before any cash changes hands. The trigger is the economic event: an employee works the hours, the electricity is consumed, interest builds up on a loan, a consultant delivers the work. Once that event has happened, the company owes payment whether or not a bill exists yet, and accrual accounting requires the obligation to show up in the period it arose.

This follows the matching principle, which pairs expenses with the period, and ideally the revenue, they helped produce. If a company sold products in December using electricity consumed in December, the electricity cost belongs in December’s results even if the utility bill arrives in January.

How accrued expenses work

The journal entry

An accrual is recorded with a debit to the relevant expense account and a credit to an accrued liability account:

The debit raises expenses on the income statement, which lowers net income for the period. The credit raises liabilities on the balance sheet. When the bill is later paid, the liability is removed and cash goes down:

The payment does not touch the income statement again, because the expense was already recognized in the earlier period.

Interpreting accrued expenses

On a balance sheet, the accrued expenses line shows how much the company owes for costs already incurred but not yet paid:

• It is a current liability. Most accruals, such as wages, utilities, interest and taxes, are settled within weeks or months, so they are classified as current. They feed directly into working capital and liquidity measures such as the current ratio.
• It is not cash spent. An accrual reduces profit without reducing cash in that period. In the indirect method of preparing the cash flow statement, an increase in accrued liabilities is added back to net income within operating cash flow, and a decrease is subtracted. That adjustment is one reason operating cash flow and free cash flow can differ from net income.
• Changes matter more than the level. A rise in accrued expenses can mean the business grew, that a payroll date fell just after period end, or that payments are being stretched, so analysts read it alongside the notes and the cash flow statement.

A formula for time-based accruals

Many accruals build up evenly over time, and the amount for a partial period is a simple proration:

Accrued amount = Periodic cost × (Days or months elapsed ÷ Days or months in the billing period)

For interest, the common version is:

Accrued interest = Principal × Annual interest rate × (Time elapsed ÷ 12 months)

Hypothetical example: a company has a $500,000 loan at 6% annual interest, with interest paid quarterly. One month into the quarter, it has incurred $500,000 × 6% × 1/12 = $2,500 of interest. If the month ends before the payment date, the company books $2,500 of interest expense and $2,500 of accrued interest payable. This assumes simple interest on a constant balance; a loan with amortizing principal or a variable rate would need the actual balance and rate for each period.

Common examples of accrued expenses

• Wages and salaries earned by employees after the last payday of the period.
• Accrued compensation more broadly: commissions, bonuses, paid time off and payroll taxes earned in the period but paid later. On a balance sheet, “accrued compensation” is the liability for these amounts.
• Interest on loans and bonds that builds up between payment dates.
• Utilities used during the month but billed afterward.
• Taxes, such as income or property taxes owed for the period but due later.
• Professional fees, such as an audit fee for work on the current year that will be billed after year end, or consulting services already delivered.
• Goods and services received without an invoice, such as supplies delivered before the vendor bills.
• Warranty costs expected on products already sold.
• Expected legal settlements, where a company expects to lose a lawsuit and records the likely cost and a liability before paying anything.

Warranties and legal settlements often appear as warranty provisions or contingent liabilities, but the logic is the same: the event that creates the obligation has already happened.

Example of accrued expenses: payroll at year end

Hypothetical example. A company pays employees on the fifth day of each month for the prior month’s work. Employees earn $40,000 in December, which will be paid on January 5. The company’s fiscal year ends December 31.

If the company recorded only payments, December’s wages would land in the next fiscal year on January 5, which misstates both years.

To fix this, the company records an adjusting entry dated December 31:

Effects as of December 31:

• Salaries expense for the year rises by $40,000, so pre-tax income falls by $40,000.
• Current liabilities rise by $40,000.
• Cash is unchanged.

On January 5, the company pays:

The liability disappears and cash falls by $40,000. January’s income statement is unaffected by this payment, because the cost was already counted in December.

Do accrued expenses affect net income for the fiscal year?

Under accrual accounting, yes: the accrual moves the $40,000 into the year it was incurred and reduces that year’s net income. Under cash basis accounting, no accrual is recorded, so the expense would reduce net income in the following year, when it is paid. The total across both years is the same; only the year it lands in changes.

Estimates, reversing entries and the close

Accruals are often estimates

An accrual is often booked before the invoice exists, so the amount may be an estimate based on contracts, usage, prior bills or payroll records. Any difference from the actual invoice flows through the expense account in the period the invoice is recorded.

Reversing entries

Accruals are meant to be temporary placeholders, not permanent records. A reversing entry, dated the first day of the next period, backs out the accrual. When the real invoice is then entered through accounts payable in the normal way, the books end up with the correct amount and no duplicate.

Hypothetical example. A company estimates June electricity at $10,000 and books it in June. The bill arrives in July for $10,400.

June shows $10,000 of utility expense. July shows a net $400 ($10,400 invoice minus the $10,000 reversal), which is the true-up of June’s estimate. If the reversal were skipped, the company would carry both the $10,000 accrual and the $10,400 payable, and expenses would be overstated by $10,000.

Without reversals, the payment can be applied directly against the accrued liability, with only the $400 difference recorded as expense. Both methods reach the same result; reversals simply let the accounts payable team process invoices normally.

Month-end and year-end accruals

Most accruals are booked during the close rather than throughout the month. A typical sequence:

1. The accounts payable team records as many actual invoices as possible before the period’s AP ledger closes.
2. Accounting staff review contracts, receiving records, payroll calendars, loan schedules and recurring bills to find costs incurred but not yet invoiced.
3. Accruals are booked for those items, usually with automatic reversals for the next period.
4. Balances are reviewed for estimates that need updating and for accruals that should have reversed but did not.

This happens at every monthly close and carries particular weight at each fiscal quarter end and at year end, when financial statements are reported externally or audited.

Why accrued expenses are important

More accurate period results. Recording expenses when incurred lines costs up with the activity that produced them, so profit margins and measures such as EBITDA reflect a complete set of expenses.

Consistency from month to month. Without accruals, a month with three paydays or two utility bills looks more expensive than one with one, purely because of payment timing. Accruals remove that distortion so trends reflect the business rather than the calendar.

A full picture of obligations. The balance sheet shows what the company owes, including bills that have not arrived. A lender or investor reading only invoiced payables would understate the company’s short-term obligations.

Reporting requirements. U.S. GAAP and IFRS are both accrual frameworks, so companies that prepare financial statements under them, including those filing with the U.S. Securities and Exchange Commission, must record accrued expenses.

Limitations of accrued expenses

More work and more judgment. Accrual accounting needs more journal entries, more review and more documentation than cash accounting. Identifying unbilled costs depends on information from across the business.

Risk of misstatement. Common errors include accruals that never reverse, accruing a cost that was already paid or invoiced, and estimates that are far off. Each misstates both expenses and liabilities.

Room for manipulation. Because accruals involve estimates, they can shift profit between periods: over-accruing lowers current profit and creates a cushion to release later, while under-accruing flatters current results. For U.S. public companies, the Sarbanes-Oxley Act requires management to maintain and assess internal controls over financial reporting, so a pattern of unsupported accruals can raise control and audit issues, not just accounting errors.

Accrued expenses vs. related terms

Accrued expenses vs. prepaid expenses

These are opposites in timing. An accrued expense is incurred first and paid later, so it creates a liability. A prepaid expense is paid first and used later, so it creates an asset, because the company is owed future goods or services.

• Accrued expense example: December wages paid in January. At December 31, the company has a wages payable liability.
• Prepaid expense example: a 12-month insurance policy paid in full on January 1. The payment is recorded as prepaid insurance (an asset) and expensed one-twelfth each month as coverage is used.

Accrued expenses vs. accounts payable

Both are current liabilities for things the company owes. Accounts payable generally covers bills that have been invoiced and entered into the AP system. Accrued expenses cover costs incurred but not yet invoiced or processed, or that accumulate continuously, like wages and interest. Many accruals become accounts payable once the invoice arrives.

Accrued expenses vs. accrued revenue

Accrued revenue (or accrued income) is the receiving-side counterpart: revenue earned but not yet billed or collected. Because the company is owed money, accrued revenue is an asset, while accrued expenses are liabilities. Unearned revenue is different again: cash received before the work is done, recorded as a liability.

Accrual basis vs. cash basis accounting

Cash basis accounting records income when cash is received and expenses when cash is paid. It is simpler and tracks the bank account closely, but income in a given period depends on when bills are paid. Accrual accounting records events when they occur, which takes more effort but gives a clearer view of performance and obligations. Accrued expenses exist only under the accrual method.

FAQs

The Bottom Line

Accrued expenses matter to accountants closing the books and to investors and lenders reading financial statements. Recording costs when they are incurred places expenses in the right period and shows obligations that have not yet been invoiced. Because many accruals are estimates, careful review and reversing entries help keep expenses and liabilities from being misstated.