Accrued Liabilities (Definition)| Examples with Journal Entries

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 have been received but invoices for the have not yet been received.

It exists only in an accrual method of accounting and does not exist under the cash method of accounting. They are recorded into the financial statements during one period and are reversed in the next period. This will allow the expense incurred in actual to be charged at the accurate price when payment is made in full.

Accrued liabilities are normally periodic in nature and are paid in arrears i.e. after they are consumed. For instance, a company’s water bill is received after the end of the month in which the water is consumed. It is important to record the water expense in the period in which the water is consumed by making relevant accounting entries at the end of that particular accounting period. Accrual of expenses results in presentation of accrued expenses under the relevant account heads in the income statement and accrued liabilities on the balance sheet.

Accrued Liabilities Example

Accrued interest: Interest on an outstanding loan that has not been billed by the end of the accounting period.
Accrued payroll: Taxes on employee wages which are due in the next period.
Accrued services: service received under the current period but are billed in the next period.
Accrued wages: Employees earn wages for the service in the current period but are paid in the next reporting period.
Accrued utilities: Utilities used for your business but the bill for the same not received.

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

Starbucks Example

source: Starbucks SEC Filings

The list of accrued liabilities in Starbucks is –

Accrued Compensation and Related Costs
Accrued Occupancy Costs
Accrued Taxes
Accrued Dividends Payable
Accrued Capital and other Operating Expenditures

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 sheet. The accounting entry will, therefore, be as follows:

Step 1:- when the expense is incurred

Organization 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.

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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 entry which has been passed before in the books of accounts. 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, an invoice has not been received from the owner and thus the rental expense has not been recorded in the accounting books.

Key Assumption

Period = 12 months
Annual rent = 12,000
Accounting period = 1 month
Accrued expense per period = 12,000 x 1 / 12 = 1,000

Debt/Credit

The accrued liabilities journal entries shown above debits 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 equation is shown in the following table.

In this case, the income statement 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 tax, closing retained earnings, 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 balances.

How it is Different from Cash Accounting?

ABC Inc. 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 the month of September but not paid in that month itself, the amount will not be included on September’s income statement. This will cause the company’s total wages to be understated than what was actually incurred in the month of 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 statements for September in comparison to the cash method of accounting.