What is an accrued expense?
An accrued expense is an expense that you have entered into your
bookkeeping system but which hasn't been paid for yet.
So these are
expenses you have been billed for from suppliers that you might have an
Example of an Accrued Expense
Here is an example to make it clear:-
In October, you buy a box of paper from your local stationery supplier and you tell them to put it on your account with them. They put it on your account and give you a bill which you have to pay in November.
You take that bill and enter it into your bookkeeping system using the date that is on the bill. This bill is now in your bookkeeping system and is coded to the stationery expense account but has not been paid yet - it is classed as an accrued expense.
If they issued you the bill and you paid it on the same day, it is not an accrued expense, it is a cash expense.
What Does 'Accrue' Mean?
According to a free online dictionary it means:-
To increase, accumulate
In accounting terms it simply means the increase of expenses that have not yet been paid. The stationery expense account in the bookkeeping system has been increased by the addition of the box of paper.
Accrued Expense on Profit and Loss Report
The important thing about accrued expenses is how they show up on your profit and loss reports.
Accrued profit and loss statements always show the expenses in the month they were purchased (the date on the bill), not the month you actually pay for them.
So if you run an accrued profit and loss report for October your stationery item (the box of paper) will show up on that report. If you run a profit and loss report for November, your box of paper will not be on the November report, even if it has been paid in November, it will still be on the October report because that is the date it was purchased.
It is the same with income. If you issue your client an invoice this month and they only pay next month, it becomes accrued income. It will show up on this month’s report, not next month’s when it is paid.
Monitoring Accrued Expenses
Accrued income and expenses are only possible to monitor with a bookkeeping system that has accounts payable and accounts receivable capabilities (one that lets you enter bills and pay them off later).
If you do an internet search about accrued expenses you may find some explanations that say accrued expenses are shown on the balance sheet as a liability. This can be misleading if you don't understand double entry bookkeeping.
This does not mean that the expense must be entered to an account on the balance sheet.
Whether you pay a bill today as a cash expense or pay it next month as an accrued expense it still has to be entered to one of the expense accounts on your profit and loss (with the exception of asset purchases).
Double Entry Bookkeeping - Accrued Expenses
Here is how an accrued expense (using stationery as an example) affects the accounts in double entry bookkeeping, and this explains what is meant by entering the expense to the balance sheet:-
- Debit (or Increase) the Stationery expense account (which shows up on the profit and loss report),
- Credit (or Increase) the Accounts Payable account (which shows up on the balance sheet as a liability - so this is the balance sheet portion)
Then, when the bill is paid:-
- Debit (or Decrease) the Accounts Payable account (balance sheet liability),
- Credit (or Decrease) the Bank account (balance sheet asset)
Capitalizing Accrued Expenses
How do you know when an accrued expense (a purchase made on account) should be an asset purchase?
Well, asset purchases usually cost over $500 (excluding sales tax or GST depending what country you are in) and they are not items that are charged out to a customer.
Read more about these here.
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