Accrued Liabilities

What are Accrued Liabilities?

Accrued liabilities are the liabilities against expenses which are incurred by the company over one accounting period by the company but the payment for the same has not been actually made by the company in the same accounting and are recorded as the liability in the balance sheet of the company.

They are those expenses that have not yet been paid under accounts payable. In other words, it is an obligation on the company to pay for goods and services that they received, but invoices for the same have not yet been received.

It exists only in an accrual method of accountingAccrual Method Of AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more and does not exist under the cash method of accounting. These are recorded into the financial statements during one period and reversed in the next period. It will allow the expense incurred in actual to be charged at the accurate price when payment is made in full.

Accrued liabilities usually are periodic and are paid in arrears, i.e., after consumption. For instance, a company receives a water bill after the month-end in which the water is consumed. It is essential to record the water expense in the period in which the water is consumed by making relevant accounting entriesRelevant Accounting EntriesAccounting Entry is a summary of all the business transactions in the accounting books, including the debit & credit entry. It has 3 major types, i.e., Transaction Entry, Adjusting Entry, & Closing Entry. read more at the end of that particular accounting period. Accrual of expenses results in the presentation of accrued expensesAccrued ExpensesAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited.read more under the appropriate account heads in the income statement and accrued liabilities on the balance sheet.

Accrued-Liabilities

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Source: Accrued Liabilities (wallstreetmojo.com)

Accrued Liabilities Example

There is a tiny but important difference between accrued liabilities and accounts payable. While such liabilities are recorded at the end of each accounting period and involve considerable estimation, accounts payable normally record as the normal course of business based on proper invoices from suppliers.

Starbucks Example

Accrued Liabilities Example

source: Starbucks SEC Filings

The list of accrued liabilities in Starbucks is –

Accrued Liabilities Journal Entry

The expense will be debited to record the accrued expense in the income statement, and a corresponding payable is created on the liability side of the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more. The accounting entry will, therefore, be as follows:

Journal Entry of Accrued Liabilities

Step 1:- when the expense is incurred

Organizations incur the expense in a particular accounting period and own debt but have not yet been billed. We need to make the record of this expense as an accrued liability in the books of accounts. We need to debit the expense account. This debit entry will increase expenses.

Also, we need to create an accrued liability expense account and credit it with the same amount. It will increase our liability.

Debit                                                             expense

Credit                                                            expense payable

Step 2:- when payment is made

In the next accounting period, when payment is made, you need to reverse the original entryReverse The Original EntryReversing entries refer to those journal entries passed in the current accounting period to offset the entries for outstanding expenses and accrued income recorded in the immediately preceding accounting period.read more, which has been passed before in the books of accounts. In order to reverse the transaction, debit the accrued liability account. The debit will decrease liability and credit cash or bank account because you paid the expense in cash. It will decrease the assets also.

Debit                                                          expense payable

Credit                                                         cash

Examples

A business has an annual building rent of 12,000. However, it did not receive an invoice from the owner, and thus the rental expense did not record in the accounting books.

Key Assumption

Debt/Credit

AccountDebitCredit
Rent Expense1,000
Accrued Expense1,000
Total1,0001,000

The accrued liabilities journal entries shown above debit the rent expense account that represents the cost to the business of that particular month for using the premises. The credit entry, which reflects the liability to pay the supplier (owner of the building) for the amount of service consumed during the period, is credited accrued expenses.

Balance Sheet

As per the Accounting Equation, Assets = Liabilities + Equity. For this transaction, the Accounting equationAccounting EquationAccounting Equation is the primary accounting principle stating that a business's total assets are equivalent to the sum of its liabilities & owner’s capital. This is also known as the Balance Sheet Equation & it forms the basis of the double-entry accounting system. read more is shown in the following table.

Journal Entry 1

In this case, the income statementThe Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more incurred a rent expense of 1,000, and balance sheet liabilities (as accrued expenses) has been increased by 1,000. The expense in income statement reduces the profit after taxProfit After TaxProfit After Tax is the revenue left after deducting the business expenses and tax liabilities. This profit is reflected in the Profit & Loss statement of the business.read more, closing retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more, and, therefore, owners’ equity in the business.

Importance

When a company prepares financial statements using accrual accounting, prepared financial statements are more accurate as it is a complete measure of the transactions and events for each period.

This complete picture helps analysts to better understand a company’s present financial health and predict its future financial position in a better way. This is unlike the cash basis method of accounting, which only records financial transactions and events when cash is exchanged, resulting in understatements and overstatements of income and account balancesAccount BalancesAccount Balance is the amount of money in a person's financial account, such as a savings or checking account, at any given time. Furthermore, it can refer to the total amount of money owed to a third party, such as a utility company, credit card company, mortgage banker, or other similar lender or creditor.read more.

How is it Different from Cash Accounting?

ABC Inc.’s biweekly pay period ends Sept. 30, and salaries to the employees will be paid two days later that is on Oct. 2. The total amount of wages that are owed to employees for the period ending Sept. 30 are $15,000.

Cash Basis Accounting

Since the last bi-weekly payroll of $15,000 was incurred in September but not paid in that month itself, the amount will not be included in September’s income statement. It will cause the company’s total wages to be understated than what was actually incurred in September, which in turn causes the company’s profit to appear higher than actual.

Accrual Liabilities Accounting

The entry will be made at September-end as follows: — Credit wages payable $14,000 –Debit wages expense $14,000. This entry results in a more complete, accurate presentation of the company’s liabilities and expenses on its financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more for September in comparison to the cash method of accounting.

Accrued Liabilities Video

This article has been a guide to what is Accrued Liabilities and its definition. Here we discuss accrued liabilities journal entries along with practical examples (Starbucks) and its importance. You may also have a look at these articles below to learn more about Accounting basics –

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